ECB: Core inflation risks in the euro area have peaked

Risks to core inflation in the euro area

Three European Union banks failed to meet mandatory capital requirements in a stress test conducted by the European Central Bank (ECB). As a result, a theoretical 496 billion euros ($546 billion) was withdrawn from their reserves.

The European Banking Authority (EBA) said 70 banks were subject to the audit, 20 more than in 2021. Eurozone banks (57 organizations in total) accounted for about 75% of banking assets in the EU. The EBA did not name the banks that failed the test.

The toughest test, according to the supervisory body, was the one that replicated a three-year scenario, with a 6% drop in economic growth and a significant fall in real estate prices. The EBA was interested in what credit, market and operational risks such a scenario posed to the bank's required core capital.

Banks started the test with an average reserve of 15% of their risk-weighted assets and incurred losses of €496 billion over the course of the test. This led to a 459 basis point reduction in reserves to an average of 10.4% by the end of the third year of testing.

Median and average measures of core inflation in the eurozone indicate it has probably peaked in the first half of 2023, and while most indicators show signs of weakening, overall it remains high. This is stated in the materials of the European Central Bank. The observed trend is "broadly in line" with June forecasts, the paper said.

The weakening of inflation is mainly due to non-energy industrial goods, the ECB writes, adding that the decline in prices for services seems to have also begun. At the same time, the regulator notes that domestic price pressures are becoming more prominent.

"Core inflation measures should reflect more stable and generalized price developments, abstracting from volatile or non-factor changes in relative prices, and thus provide an informative signal of where core inflation will be in the medium term," the ECB says in the document.

As the European regulator notes, the exact level of inflation remains difficult to determine. In June, indicators ranged from 2.9% (PCCI, the constant and total component of inflation) to 6.9% (HICP - consumer inflation excluding energy). The domestic inflation indicators - PCCI and HICPXX (consumer inflation excluding energy, food, travel-related items and clothing) - are performing best, the ECB emphasizes.

The ECB recommends complementing the core inflation tracking with "careful monitoring of factors that are likely to determine domestic price pressures over the medium term, in particular incoming data on wages, profits and inflation expectations".

The day before, outgoing ECB Executive Board member Fabio Panetta said that underlying inflationary pressures are easing, but warned that empirical evidence suggests that so-called core price growth "is a lagging rather than leading indicator," Bloomberg notes. "Today's core inflation numbers tell us little about where core inflation will move over the medium term," Fabio Panetta said.

According to ECB chief economist Philip Lane, price pressures in the eurozone "should ease significantly later this year."

Bloomberg recalls that in the eurozone, consumer prices rose 5.3% last month from a year earlier, half the rate seen in 2022. Core inflation remained at 5.5% and both are expected to fall short of 2% by the end of 2025.


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