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Eurozone’s inflation-growth mix is likely to convince policymakers that the economy can withstand further monetary tightening. Inflation jumped to 3.3% yoy in August from 2.9% month before, moving further from the 2% target, primarily driven by 14.3% increase in the energy component. Core inflation, however, stayed steady at 2.4% yoy, accompanied by softening service inflation, suggesting spillover risks are limited at this juncture. However, from the ECB's perspective, the risk is that sustained increase in inflation eventually broadens into wages, services and inflation expectations, preferring to act pre-emptively. In recent comments, ECB Executive Board member Isabel Schnabel argued that further tightening would be necessary, as the current policy rate was unlikely to be enough to bring inflation back to its target in the medium term. Compared to mixed signals from the US Fed, the ECB's framework has been more streamlined in recent months. We expect a 25bp hike at next week's rate review.
On the real activity end, incoming data has been mixed. August PMI prints firmed up from July besides steady rise in production, while industrial confidence softened marginally. Retail sales slowed in June, even as the European Commission’s economic sentiment survey proved to be resilient, including the employment sub-indices. While growth is far from booming, the economy is not exhibiting the degree of weakness that would justify overlooking an inflation overshoot. Meanwhile, sell off in the global bonds has also swept European rates higher. For instance, German 10Y yields approached the highest levels since 2011 (at the time of writing), French 10Y at the highest in little less than two decades, causing the spread between the two yields to widen to the most in almost two years, suggesting investors are growing wary of wide deficits in light of geopolitical tensions, higher defence expenditure and other prevailing uncertainties. Directed measures to contain yields is unlikely though a hawkish ECB should help anchor l-t yields.
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