Investors will be monitoring the Euro area’s consumer price index reading for December that will be released on Jan 6th , 2023. The next forecast is expected to read 9.7%%, down 0.4% from October’s 10.1%. it would be a relief for the ECB if December 2022 YoY headline inflation forecast reads below 10.1, being the second consecutive lower reading YTD since October 2022’s 10.6 peak. As well known, the CPI index measures the change of prices for products and services over a specific time, and it is a key barometer for measuring purchasing trends as well.
Since July 2022, the European central bank has been following an aggressive tightening policy by raising interest rates aiming to tame inflation; the interest rate in the EU is currently 2.5%, with October and September characterized by the highest consecutive pace of interest rate increase by 75 basis points each (Fig1). This is justified by energy market uncertainty and volatility, currently contributing to 41.5% of headline inflation. Moreover, the EU unemployment rate is at a record low of 6.5% as per the latest data for October 2022.
As announced, the EU is banning Russian oil imports since December 5th and refined products on February 5th, 2023; accordingly, this would cause energy supply disruption in the region as alternative energy sources wouldn’t be enough to fill the gap. European natural gas reached all time high of $70/mmbtu in August 2022 due to aggressive actions by the EU to import LNG to compensate the Russian gas and build their inventories which reached almost 90% by October 2022. Putting an end to LNG price war, EU member states agreed to cap gas prices at €180 per megawatt-hour - $56/mbtu however, for the cap to take effect, contracts must be above the ceiling for three days and above LNG prices to a certain degree. Opinions criticizing the decision on the long term the price cap won’t be in the EEU’s favor as LNG exporters will be favoring Asia for higher prices. Furthermore, not associating a demand cap in parallel to the price cap will encourage consumption, falling in the pitfall of insufficient supply.
As stated by Christine Lagarde in the ECB December 2022 meeting: “we judge that interest rates will still have to rise significantly at a steady pace to reach levels that are sufficiently restrictive to ensure a timely return of inflation to our two per cent medium-term target. Keeping interest rates at restrictive levels will over time reduce inflation by dampening demand and will also guard against the risk of a persistent upward shift in inflation expectations”
(fig.1) source: www.tradingview.com
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