ECB: One-year ETS2 Delay Prompts Steepening In 2s3s EUR Inflation Curve

EU member states have agreed to delay ETS2 - the new carbon market pricing scheme  - by one year to 2028. The ECB had estimated that this scheme would push up 2027 inflation by ~0.3pp in its September macroeconomic projections. As such, the delay should imply a mechanical reduction of the 2027 inflation projection December, compensated almost one-for-one with an increase in the 2028 projection (which will be presented for the first time next month). 

• Following the news, the 2s3s EUR inflation curve has steepened almost 5bps to 1.6bps. However, it’s notable to us that this has solely been driven by the 3-year swap (1.84% vs 1.79% yesterday), with the 2-year swap little changed at 1.83%. This may leave scope for further near-term steepening in 2s3s.
• Recent policymaker signalling suggests the ECB will avoid making monetary policy decisions (i.e. delivering another cut) solely on the basis of an ETS2-implied undershoot in 2027/2028.
• In an interview released yesterday (i.e. before the ETS2 announcement), Bank of Greece Governor Stournaras told MNI that while the 2028 projections will be a “key input” for the ECB, other data and “judgement” will play an important role. He suggested that he would be more concerned if spot inflation rates fall below target (Flash October headline was 2.1% Y/Y, core was 2.4%).
• Other relevant comments over the last few weeks:
  • Kazaks (31 Oct) "The 2028 forecast will be very important to look at, to see where inflation dynamics are going, but I would not overestimate the importance,"...."Uncertainty remains high and is unlikely to disappear, so forecasts will come with a very large margin of error"
  • Kocher (31 Oct): “The 2028 projection is of course a projection that is far out into the future,” ....“So putting too much weight on this projection, on this single data point, I think would not be appropriate.”