SPEECH

Disinflation in the euro area

Speech by Philip R. Lane, member of the Executive Board of the
ECB, Hutchins Center on Fiscal & Monetary Policy at the Brookings
Institution

Washington, D.C., 8 February 2024

Today, I wish to report on the progress in disinflation in the euro area.

Chart 1 shows the dynamics of headline and core inflation, extended forward through 2026 on the basis
of the December 2023 Eurosystem staff projections. Relative to its pandemic low point in late 2020,
inflation started to increase in early 2021, rising above the two percent medium-term target in July
2021. Inflation continued to climb through the rest of 2021 and most of 2022, peaking at 10.6 percent in
October 2022. Since late 2022, inflation has declined and stood at 2.8 per cent in January 2024.
According to the December 2023 Eurosystem staff projections, inflation is expected to stabilise around
the two per cent target from about the middle of 2025 onwards.

Chart 1
Headline inflation, core inflation and Eurosystem staff macroeconomic projections

(annual percentage changes)

= Realised HICP @ HICPX December 2023 Eurosystem staff projections
= Realised HICPX @ HICP December 2022 Eurosystem staff projections
@ HICP December 2023 Eurosystem staff projections > HICPX December 2022 Eurosystem staff projections

e@ee
8 MS eoereeeon

2
Jan-19 dul-19 Jan-20 dul-20 Jan-21 Jul-21 Jan-22 dul-22 Jan-23 dul-23 Jan-24 dul-24 Jan-25 Jul-25 Jan-26 Jul-26

Sources: Eurostat and Eurosystem staff macroeconomic projections.

Notes: HICP refers to headline inflation and HICPX to HICP excluding food and energy. Realised HICP and HICPX
are at a monthly frequency, and HICP and HICPX projections are at a quarterly frequency. The latest observations
for realised HICP and HICPX are for January 2024 (flash).

The main factors in the 2021-2022 inflation surge were the direct and indirect effects of the energy
shock, together with a set of pandemic-related factors including supply chain bottlenecks and, during

2022, the Russian invasion of Ukraine and demand-supply mismatches associated with the reopening
of the contact-intensive service sectors (Chart 2).

By the time headline inflation peaked at 10.6 per cent in October 2022, energy inflation had reached
41.5 per cent. Since then, energy inflation has not only stabilised but turned negative: in January 2024,
it stood at -6.3 per cent. The energy shock also contributed to very high food inflation: at 5.7 per cent in
January, food inflation has come down substantially from its peak of 15.5 per cent in March 2023 but
remains elevated. Core inflation was 3.3 per cent in January, down from the 5.7 per cent peak also in
March 2023. The decline in goods inflation has been the main driver in core disinflation, with goods
inflation standing at 2.0 per cent in January, down from 6.8 per cent in February 2023. Inflation in the
services sector stands at 4.0 per cent, having eased less so far than the other components; its peak
was 5.6 per cent in July 2023.

Chart 2
Inflation developments and December 2023 Eurosystem staff macroeconomic
projections

(annual percentage changes, percentage point
contributions)
@ Senices @ Energy ®@ > HICP excluding energy and food
B Goods = HICP Food
@ Food im Energy
m= HICP (December 2023 Eurosystem staff projections)
12 12
10 10
8 8
6 6
4 4
. TOOL
on ~ te I lon 0
-2 2
dan-21 Jul21 Jan-22 Jub 22 Jan-23 Jub 23 Jan-24 2401 2403 25Q1 2503 2601 2603

Sources: Eurostat, December 2023 Eurosystem staff projections and ECB calculations.
Note: The latest observations are for January 2024 (flash).

Overall, the strong disinflation over the past year largely reflects the unwinding in energy inflation
(which, in turn, partly reflects large base effects), which explains about half of the disinflation (Chart 3).
In addition, the ongoing easing of pipeline pressures and the relaxation of supply bottlenecks have
supported the disinflation in the other HICP components. Monetary policy tightening has contributed to
the disinflation process by dampening demand and anchoring medium-term inflation expectations at
our two per cent target.

Chart 3
Headline inflation vis-a-vis January 2023

(percentage points)

SX Energy base effects B Core
@ Energy excl. base effects = HICP
© Food
2
0 -
NY W

TZ
WA
Wi,

Jan-23 Feb-23 Mar-23 Apr-23 May-23 Jun-23 Juk23 Aug-23 Sep-23 Oct-23 Nov-23 Dec-23 Jan-24

Sources: Eurostat and ECB calculations.

Notes: The notion of base effects is explained, inter alia, in the ECB Economic Bulletin box entitled "Recent
dynamics in energy inflation: the role of base effects and taxes". The latest observation is for January 2024
(flash).

While the December 2022 projections had foreseen considerable disinflation during the course of 2023,
the realised pace of disinflation has exceeded these estimates (Chart1). Energy prices not only
stabilised but fell considerably in the course of 2023 (Chart 4), including due to the impact of global
monetary tightening on world activity levels and commodity prices.

Chart 4
Oil and gas prices

== Spot w= December 2023 Eurosystem staff macroeconomic projections
= Futures (latest)

Brent crude oil (USD barrel) Gas (EUR/MWh)
100 80
95 70
90 60
85 50
80 40
76 30
70 20
Jan-23 Julk23 Jan-24 Juk24  Jan-23 Jul-23 Jan-24 Jub 24

Sources: LSEG, ECB staff calculations and Eurosystem/ECB staff projections.
Note: The latest observations are for 6 February 2024.

The downward revisions to 2023-2024 growth reflected unexpectedly-weak global demand for
European exports and the under-estimation of the adverse impact of the 2021-2022 decline in real
incomes and the terms of trade on consumption and investment dynamics. In addition, the scale of
deceleration in credit dynamics was underestimated.

During the disinflation process, forecast errors have been small, and even turned negative in recent
times (Chart 5 and Chart 6). This stands in contrast to the inflation surge period, which triggered
substantial one-quarter ahead forecast errors in September 2021 ECB staff macroeconomic projections

and the following rounds./2]

Chart 5
One-quarter ahead HICP forecast errors - comparison with other forecasters

(percentage points)

mEurosystem/ECB staff

= European Commission 4 Plus one month of data
m Survey of Monetary Analysts v_ Minus one month of data
mEESE Md Minus two months of data

m Consensus Economics

v
Vv
Vv v
v
Vv
v v
2 a
4 cy
1 a
iN ins Wi
A
ha a .
fl

2104 2201

cn

I
4a
Ppa
=
--_=
I

a
.
I *

v

Ni

21Q1 21Q2 2103

Sources: Eurosystem/ECB staff projections, Consensus Economics, Survey of Monetary Analysts (SMA),
European Commission, OECD and Eurostat.

Notes: See also Chahad, M., Hofmann-Drahonsky, A.-C., Page, A. and Tirpak, M. (2023), "An updated assessment
of short-term inflation projections by Eurosystem and ECB staff', Economic Bulletin, Issue 1/2023, ECB. For other
forecasters, the errors are shown for publications where the corresponding cut-off date is closest to that of the
Eurosystem/ECB staff projections. For the SMA, the median of survey respondents is shown. The arrows indicate
differences in the months of available HICP data at the cut-off point for each publication relative to the
Eurosystem/ECB staff projections. An upward arrow indicates one additional month of data, a downward arrow
indicates one month less data, and two downward arrows indicate two months less data. Quarterly projections from
the OECD are only available twice per year and therefore no error is shown in the first and third quarters. Notes on
errors for third and fourth quarters of 2023: The European Commission did not publish quarterly forecasts in its
Summer 2023 forecast, so no errors are depicted in the chart. The cut-off date for the Eurosystem/ECB staff
projections was 30 August 2023. Although this was one day before the publication of the euro area HICP flash
estimate for August 2023, flash releases for five euro area countries (covering 45% of the euro area HICP) were
included implying no deviation from the Eurostat release for headline HICP.

Chart 6
Decomposition of recent one-quarter-ahead HICP inflation errors in the
Eurosystem/ECB staff projections

(percentage points)

Total error

Impact of energy price assumptions and other factors affecting HICP energy
Indirect impact of energy prices on non-energy inflation

Impact of nom energy related assumptions

Other factors affecting HICP food

Other factors affecting HICP excluding energy and food

24
20 e a
15 e

10
e e e
os
a « & . fi
a _ z= a
05 e
10
15
-20

2004for 2101 for 2102for 2103for 2104for 2201 for 2202 for 2203 for 2204 for 2301 for 2302 for 2303 for
2104 2102 2103 2104 2204 2202 2203 2204 23041 2302 2303 2304

Source: ECB calculations.

Notes: See also Chahad, M., Hofmann-Drahonsky, A.-C., Page, A. and Tirpak, M. (2023), "An updated assessment
of short-term inflation projections by Eurosystem and ECB staff', Economic Bulletin, Issue 1/2023, ECB. "Total
error" is the outturn minus the projection. "Indirect impact of energy prices on non-energy inflation" is the sum of the
indirect effects of oil, gas and electricity prices. (For oil, these are based on the elasticities derived from the
Eurosystem staff macroeconomic models, and for gas and electricity these are computed assuming an elasticity
proportional to the oil price shock.) "Impact of non-energy related assumptions" represents the assumptions for
short and long-term interest rates, stock market prices, foreign demand, competitors' export prices, food prices and
the exchange rate.

Charts 7 and 8 compare the current inflation episode in the euro area to a sample of past episodes. 2]
The scale of the inflation shock to headline exceeds previous episodes, which reflects not only the
energy shock but also the preceding rebound from the very low inflation during the initial months of the
pandemic. The disinflation of headline inflation so far is proceeding in a fairly symmetrical fashion.
However, core inflation measures have peaked later and remain at relatively high levels from a
historical perspective. This is driven primarily by the dynamics of services inflation, whereas goods
inflation has already come down more decisively. Amongst other factors, the adjustment of the services
sector to rising energy costs and the impact of the price level shock on subsequent nominal wage
dynamics is necessarily a gradual process, especially in view of the staggered nature of the wage
setting process in European labour markets. In addition, the pandemic reopening effect was still
supporting unusually high pricing power in contact-intensive services sectors through the summer of
2023.

Chart 7
Historical inflation and the recent inflation episode in the euro area - headline and
core inflation rates

Headline inflation Core inflation
(percentage points) (percentage points)
= Current euro area episode = Current euro area episode
® Past global episodes © Past global episodes
2 2

12 -24 "18 12 6 0 6 12 18 24
-24 00 18-12 -6 Q 6 12 18 24

Months around inflation peak Months around inflation peak

Sources: BIS, Eurostat, and ECB calculations.

Notes: The shaded areas and the orange and yellow lines represent respectively the interquartile range and the
median of national headline and core inflation series relative to their peaks during disinflation episodes before 2022
across a panel of 30 advanced economies and 28 emerging market economies. Month = 0 when the headline
inflation rate is at its highest during that particular episode. The dark blue line represents the latest developments in
headline and core inflation for the euro area, relative to the October 2022 peak. The latest observations are for
January 2024.

Chart 8
Historical inflation and the recent inflation episode in the euro area - goods and

services inflation rates

Non-energy industrial goods Services inflation
inflation
(percentage points) (percentage points)
= Current euro area episode = Current euro area episode
tm® Past global episodes ® =Past globalepisodes

: -24 -18 "12 6 Q 6 12 18 24 724 18 -12 6 it) 6 12 18 24
Months around inflation peak Months around inflation peak

Sources: BIS, Eurostat, and ECB calculations.

Notes: The shaded areas and the blue and green lines represent respectively the interquartile range and the
median of national NEIG and services inflation series relative to their peaks during disinflation episodes before
2022. Non-energy industrial goods inflation refers to a panel of all euro area countries, while services inflation
refers to a panel of 30 advanced economies and 28 emerging market economies. Month = 0 when the headline
inflation rate is at its highest during that particular episode. The dark blue line represents the latest developments in
non-energy industrial goods and services inflation for the euro area, relative to the October 2022 peak. The latest
observations are for January 2024.

In the December 2023 Eurosystem staff macroeconomic projections, HICP inflation is projected to
decrease from an average of 5.4 per cent in 2023 to 2.7 per cent in 2024 and 2.1 per cent in 2025, and
then to stand at 1.9 per cent in 2026 (Chart 1). In 2024, energy inflation should increase as base effects
turn positive and some fiscal support measures are scheduled to be discontinued. This is expected to
partly offset further declines in food inflation and HICP inflation excluding energy and food (HICPX),
implying that headline inflation will fall only gradually in the course of 2024. From the end of 2024, all
the main inflation components are expected to continue to ease, supporting headline HICP inflation in
reaching the ECB's target in the second half of 2025.

Inflation could decline more quickly in the near term if energy prices evolve in line with the recent

downward shift in market expectations for the future path for oil and gas prices (Chart 4). This is
recognised in the risk assessment of the January ECB monetary policy statement. It is also reflected in

the Consensus expectations of external experts, which are below the December 2023 Eurosystem staff
projections in the near term (Chart 9). Work by ECB staff (Lenza et al. (2023) - using a
machine-learning approach with about 60 variables, weighted according to their track record - also
points to the possibility of outturns below the December projections. 4] That said, it is worth
emphasising that the confidence bands associated with the analysis are very wide, which cautions
against putting too much weight on the centre of the distribution.

Chart 9
Short-term forecasts

(annual percentage changes)
@ HICP
® December 2023 Eurosystem staff projections @ HICPx
= Consensus (8 January 2024) ® December 2023 Eurosystem staff projections
= Regression forest mean tm Regression forest mean
4 4
3 > 3 ~
° . ro e e °
2 2
1 1
0 0
Jan-24 Apr-24 Juk24 Oct-24 Jan-25 Jan-24 Apr24 Juka4 Oct-24 Jan-25

Sources: Eurostat, December 2023 Eurosystem staff projections, Consensus Economics and ECB calculations.
Notes: Cut-off date for the random forest is 1 February 2024. Consensus Economics data were collected on 8
January 2024. Random forest estimates are from Lenza, M., Moutachaker, I. and Paredes, J. (2023),

"Forecasting euro area inflation with machine learning models", Research Bulletin, No 112, ECB. The latest
observations are for January 2024 (flash).

The broad range of underlying inflation measures have come down substantially from their peaks and
also fell in December, reflecting the fading impact of past shocks and weaker demand, including due to

the ongoing strong transmission of tighter monetary policy (Chart 10). However, while at a general
level, measures of underlying inflation are meant to capture the persistent component of inflation and
therefore send signals about medium-term inflation, the relative price shocks that have been triggered
by the scale and breadth of the energy shock and the pandemic- and war-related shocks mean that
standard measures of contemporaneous underlying inflation may, in fact, not send reliable signals
about medium-term inflation dynamics.

Making an adjustment for the impact of energy costs and supply bottlenecks on core inflation deliver

measures that peaked at lower levels. The difference between the adjusted and standards measures

of underlying inflation suggests that the temporary factors amounted to at least two and a half

percentage points at the peak. There is still around one per cent of temporary factors in the unadjusted
measures as of now, but the difference is fading out gradually. In addition, this adjustment technique
does not correct for the additional pricing power of firms in contact-intensive services during the
pandemic reopening phase. To the extent that this effect is also fading out, further deceleration in
underlying inflation can be expected.

Chart 10
Measures of underlying inflation

(annual percentage changes)

m= HICPX = HICP excluding energy

we HICPXX = Supercore

= Domestic inflation tm PCCI

= HICP excluding unprocessed food and energy tm PCCI excl. energy

Standard measures Adjusted measures Difference

8 8 4
t 7
6 6 3
5 5
4 4 2
3 3
2 2 1
1 1
Q 0 Q
Jan-23 Jul-23 dan-24 Jan-23 Jul-23 Jan-24 Jam23 Jub 23 Jan-24

Sources: Eurostat and ECB staff calculations. Notes: "PCCI" stands for "persistent and common component of
inflation". The 'adjusted' measures abstract from energy and supply-bottleneck shocks using a large SVAR, see
Banbura, Bobeica and Martinez-Hernandez, (2023), "What drives core inflation? The role of supply shocks",
", Working Paper Series, No 2875, ECB), deducted mechanically from each measure. The latest observations are
for January 2024 (flash) for HICP excluding energy, HICP excluding energy and food, and HICP excluding energy
and unprocessed food in the left panel, December 2023 for the rest.


Chart 11
Momentum of inflation and its components

(annualised three-month-on-three-month percentage

changes)
@ HICP oo Energy (right-hand scale) @ HicPx = Services
= Food - Goods

14 30 8

20 7

Jan-23 May- 23 Sep-23 Jane24 Jan-23 May-23 Sep-23 Jan-24

Sources: Eurostat and ECB calculations.
Notes: Calculated using seasonally adjusted data. The dashed line corresponds to services adjusted for the effects
of the €9 and €49 tickets introduced in Germany in June 2022 and May 2023 respectively.

The latest observations are for January 2024 (flash) for food, energy and goods, December 2023 for the rest.
Missing data points for January 2024 will become available with the HICP release on 22 February 2024.

Momentum indicators have eased further for headline inflation and all of its components (Chart 11). The
annualised three-month-on-three-month growth rate of seasonally-adjusted HICPX stand at 1.4 per
cent, with momentum in goods inflation at zero and momentum in services inflation close to 2 per cent,
while the momentum of food inflation is around 3 per cent.

Taken at face value, these readings might be interpreted as challenging the medium-term forecast.
However, according to the staff projections, several factors are expected to raise momentum in the
coming months, for both headline and core inflation. First, the windfall of plunging input costs through
lower energy costs and lower intermediate prices, which may have temporarily muted the need for firms
to raise prices is expected to level out. This, in turn, means that rising wage costs (even at the
decelerating rate foreseen in the projections) will exert stronger upward pressure on overall costs.
Second, the projections foresee a recovery in domestic and external demand this year. All else equal,
this will increase pricing power compared to last year. Third, many of the fiscal measures that leaned
against strong price pressures in 2022 are scheduled to expire, which will act to push up prices in the
near term. This combination of factors explains why the overall trajectory of inflation in the December
2023 projections only converges to the target in the second half of 2025.

In assessing the wage data, compensation per employee from the national accounts provides the most
comprehensive measure (Chart 12). However, these data become available only with a lag of over two

months. According to the December 2023 Eurosystem staff macroeconomic projections, euro area
wage growth is expected to have peaked in 2023 but to remain above the medium-term steady state
level during 2024 and 2025, reflecting the ongoing gradual correction of the real wage gap that was
generated by the 2021-2022 inflation surge, together with robust labour markets.

Growth in compensation per employee edged downward to 5.3 per cent in 2023Q3 from 5.5 per cent in
the previous two quarters. Forward-looking wage trackers provide timely and higher-frequency
complements to the official wage data releases and may act as leading indicators for the subsequent
releases of the official compensation per employee data. One important indicator from the wage
tracker is average wage growth for twelve months ahead, as embedded in agreements reached in the
latest quarter (Chart 13). This indicator also gradually edged down in the second half of 2023. Many

wage agreements will be renewed in the early months of 2024, and updates to the wage trackers will
provide essential information in projecting wage dynamics.

Chart 12
Indicators of euro area wage growth

(annual percentage growth and percentage point contribution)

= Compensation per employee vn Wage drift
= Compensation per hour = Unit labour costs

mm Negotiated wages

2201 2202 2203 2204 2301 2302 23Q3

Sources: Eurostat, ECB and ECB calculations.
Notes: "Wage drift" measures deviations between developments in actual wages as measured by wages and
salaries and developments in negotiated wages. The latest observations are for the third quarter of 2023.

Chart 13
Euro area wage tracker

(percentage points contributions)

@ Structural @ One-offs

Wage growth in latest agreements

Q1 22 Q22 Q3 22 Q4 22 Q123 Q2 23 3 23

a

S

w

Sources: Calculated based on micro data on wage agreements provided by Deutsche Bundesbank, Banco de
Espajfia, the Dutch employer association (AWVN), Oesterreichische Nationalbank, Bank of Greece, Banca d'ltalia
and Banque de France.

Notes: Euro area aggregate based on DE, FR, IT, ES, NL, AT, GR, as of December 2023.The indicator of latest
agreements reflects wage growth in the agreements reached in a certain quarter for the 12 months after an
agreement. One-offs payments are spread over 12 months from the agreed disbursement date - smoothing the
impact of one-off payments on wage growth. Data of latest agreements for Q4 2023 preliminary as not all collective
agreements reached in Q4 2023 are available yet. For the methodology, see also Gornicka, L. and G. Koester
(eds.) 2024: "A forward-looking tracker of negotiated wages in the euro area". Eurosystem wage tracker experts.
ECB Occasional Paper No. 338. European Central Bank (forthcoming).

Latest observation is for the fourth quarter of 2023.

The available survey indicators are broadly consistent with the decreasing wage profile foreseen in the
latest Eurosystem staff projections (Chart 14). According to our most recent discussions with large
European non-financial corporations, the wage growth expectations of this set of companies for 2024
are 4.4 percent on average, which is a marked easing compared to the average 2023 wage growth of

5.3 per cent.10] Similarly, in the ECB's latest Survey of Professional Forecasters (SPF), expectations
for annual growth in compensation per employee point to a gradual decline in wage growth looking
ahead and were revised down over the longer horizon. While expectations are only slightly below that
forecasted for 2024 in the December 2023 BMPE round (by 0.15 percentage points), SPF respondents
expect a much faster decline in wage pressures in 2025 and 2026.

Chart 14
Survey-based wage expectations and the December 2023 Eurosystem staff
macroeconomic projections

(annual percentage changes)
mm SPF 2024 1 BM December 2023 BMPE

@ SPF 2023.04 mw ocrs

2024 2025 2026

5.5

5.0
45
40
3.6
3.0
26
2023

Sources: January 2024 Corporate Telephone Survey (CTS), Survey of Professional Forecasters (SPF) and
December 2023 Eurosystem staff projections.

Finally, progress along the disinflationary path will also depend on firms buffering rising labour costs
with a slowdown in profit growth. Since the aggregate level of profits surged in 2021-2022, there is
some room for profit compression without driving profitability to below-average levels (Chart 15). The
contribution of unit profits to domestic price pressures continued to fall in the third quarter of 2023,
suggesting that unit profits are absorbing some of the price pressures coming from rising unit labour
costs. The profit margin proxies derived from the responses to recent corporate telephone surveys also
suggest that this buffering process is at work (Chart 16).

Chart 15
SAFE-ORBIS profit margins

(percentages)

== SAFE- ORBIS aggregation
we Average firm
== Median firm

2013 2014 2015 2016 2017 2018 2019 2020 2021 2022

ORBIS balance sheet year

Source: ECB, European Commission survey on the access to finance of enterprises (SAFE) and Moody's ORBIS.
Notess: The SAFE-ORBIS aggregate profit margin is calculated by summing the profits before taxes and revenues
of firms in each ORBIS balance sheet year before calculating the profit margin ratio.

Chart 16
Corporate Telephone Survey (CTS)- implied profit margin

(average of Corporate Telephone Survey scores)

== Past margin
ee Future margin

04

0.0

-04

-0.2

-0.3

-0.4

-0.5

-0.6
2020 2021 2022 2023

Source: Corporate Telephone Survey (CTS).

Notes: The score is calculated as the "selling price score - 0.5 x input cost score - 0.5 x wage score. Past and

future selling and input price scores refer to developments in the previous and next quarters. The dashed lines
represent the 2009-2019 average for "past" and "future". Latest observations are from the 2024 January CTS.

Finally, a successful disinflation process requires inflation expectations to be anchored at the two-per
cent target over the long term. Taking a longer view, following the protracted period of below-target
inflation, between the middle of 2021 and early 2022, there was a remarkable shift in long-term inflation
expectations, with survey respondents moving away from long-held views that inflation would
indefinitely remain below the two per cent target (Chart 17). While there certainly was a marked
increase in the fraction of survey respondents that expected inflation to remain above target in the long
term, the majority of respondents assessed that the inflation shock served to re-anchor long-term
inflation expectations at the target by demonstrating that inflation risks were two-sided. In turn,
reinforced by the target-consistent monetary policy decisions during this period, the stabilisation of
inflation expectations has provided an important anchor in the disinflation process.

In this respect, it is encouraging that measures of shorter-term inflation expectations have come down
markedly more recently, while measures of longer-term inflation expectations mostly stand around 2 per
cent. In particular, the inflation expectations of professional forecasters have moved down over the
entire horizon, with longer-term expectations now standing at 2.0 per cent (Chart 18). Similarly, while
the expectations component contained in market-based measures of inflation compensation, such as
the five-year-in-five-years inflation-linked swaps, has remained anchored at two per cent throughout the

inflation episode, it is notable that risk premia have receded over recent months (Chart 19).!4)

Chart 17
Evolution of long-run inflation expectations over survey rounds

(percentage of respondents)

= Below 2%
me Above 2%
= 2%

' Strategy review
{ announcement

Jun-21 Sep-21 Dec-21 Mar-22 Jun-22 Sep-22 Dec-22 Mar-23 Jun-23 Sep-23 Dec-23

Source: Survey of Monetary Analysts (SMA).
Notes: The three groups are based on the HICP long-run forecasts provided by respondents on the
macroeconomic projections question of the SMA.

Chart 18
Professional forecasters' inflation expectations

(annual percentage changes)

mm SPF (4-5 years ahead) wm SMA (long-term)
w= Consensus (5 years ahead) = Weighted average

2.2

24

2.0

19

18
Jan-22 Jub 22 Jan-23 Jub 23 Jan-24

Sources: Consensus Economics, Survey of Professional Forecasters (SPF), ECB's Survey of Monetary Analysts
(SMA). Note: The weighted average of surveys is computed using the number of respondents in each survey as a

weight.
Latest observations: January 2024 for Consensus Economics and SMA, 2024 Q1 for SPF.

Chart 19
Decomposition of 5-year-in-5-years inflation-linked swap rate

(annual percentage changes)

ee Expectations component
== = 5y5y inflation-linked swap rate (fitted)
Risk premium component

2022 2023 2024 29-Jan

Sources: Bloomberg and ECB staff calculations

Notes: The 5y5y ILS rates (monthly data) refer to the average inflation rate over a five year period starting in five
years' time, as implied by ILS rates. The expectations component is based on average estimates from two affine
term structure models following Joslin, Singleton and Zhu (2011) applied to ILS rates (adjusted for the indexation
lag); see Burban et al. (2021), ECB Economic Bulletin Issue 8, 2021, Box 4. The latest observations are for 29
January 2024.

Conclusion

Let me conclude. The declining trend in underlying inflation has continued, and our past interest rate
increases keep being transmitted forcefully into financing conditions. By tightening financing conditions,
the restrictive monetary policy stance is dampening demand, and this is helping to push down inflation
and stabilise inflation expectations.

The December 2023 Eurosystem staff projections see inflation stabilising around the two per cent
target from about the middle of 2025 onwards. The incoming data suggest that the process of
disinflation in the near term in fact may run faster than previously expected, although the implications
for medium-term inflation are less clear. At the same time, the strength of the recovery of the economy,
the path of fiscal policies, wage developments, and the degree to which firms absorb higher input costs,
all in a context of continued heightened geopolitical uncertainty, will have an important bearing on the
inflation trajectory. The March 2024 ECB staff macroeconomic projections will provide the opportunity
for a comprehensive update of our medium-term inflation outlook.

We will continue to follow a firmly data-dependent approach to determining the appropriate level and
duration of restriction. In particular, our interest rate decisions will be based on our assessment of the
inflation outlook in light of the incoming economic and financial data, the dynamics of underlying

inflation and the strength of monetary policy transmission."2] In this process, monetary policy needs to
carefully balance the risk of overtightening by keeping rates too high for too long against the risk of

prematurely moving away from the hold-steady position that we have been in since September. In
terms of an overall evaluation of our policy trajectory, we need to be further along in the disinflation
process before we can be sufficiently confident that inflation will hit the target in a timely manner and
settle at target sustainably.

1.
I am grateful to Katalin Bodnar, Malin Andersson, Colm Bates, Anna Beschin, Cristina Checherita-
Westphal, Andrea Fabbri, Anna-Camilla Hofmann-Drahonsky, Eliza Lis, Aurora Monza, Flavie

Rousseau and Fabian Schupp for their contributions to this speech.

2.

See Chahad, M., Hofmann-Drahonsky, A.-C., Page, A. and Tirpak, M. (2023), "An updated assessment
of short-term inflation projections by Eurosystem and ECB staff', Economic Bulletin, Issue 1/2023, ECB
and Chadad, M., Hofmann-Drahonsky, A.-C., Meunier, B., Page, A. and Tirpak, M. (2022): What
explains recent errors in the inflation projections of Eurosystem and ECB staff?, Economic Bulletin,

Issue 3/2022.

3.

I thank the BIS for generous sharing of data. These charts build on the original analysis in the 2023 BIS
Annual Economic Report.

4.

Lenza, M., Moutachaker, I. and Paredes, J. (2023): Forecasting euro area inflation with machine

learning models, ECB Research Bulletin No. 112.

5.

Headline inflation is noisy since it is affected by the short-term volatility induced by temporary
idiosyncratic shocks, thereby blurring the signal about medium-term inflationary pressure that is
relevant for monetary policy. Thus, central banks monitor measures of underlying inflation in order to
distinguish signal from noise in the data. See Lane, P. R. (2022): Inflation Diagnostics, ECB