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Economy in Brief

Is the ECB Winning or Losing on Inflation?
by Robert Brusca February 29, 2008

February has seen a now dollar low VS the Euro, a new high for gold and for other precious metals, as well as repeated new highs for oil prices. In January EMU prices are up by 0.3% with inflation accelerating in its sequential growth rates: up at a 4.8% pace for three months, at a 4.2% pace for six months, at a 3.2% pace for twelve months compared to a 1.9% pace over the previous twelve months. Even so the inflation picture is brightening up in Europe.

Despite ongoing pressures from oil and now food stuffs, the core inflation rate (that ECB goes out of its way to say it does not target) is behaving in a very positive fashion. In the last three months the core rate decelerated from a monthly rate of 0.3% in Nov to 0.2% in Dec to a 0.1% rise in January. Its three month rate of change is below its six month pace. Moreover, Germany, the largest EMU economy, shows that three month of core inflation decelerated while Spain and Italy show a lower three month than six month pace.

Apart from that sort of technical trend stuff, there is the gap between the headline rate and the core. That gap has widened sequentially for EMU and for each of the countries in the table below. Yet despite this greater pull of headline inflation pressures the three-month pace of inflation has improved in three of four of the countries as well as for EMU overall.

If headline inflation does not make core inflation worse, then when the headline stops taking its pounding from the special interest inflation categories, headline inflation will settle down rapidly and gravitate toward the core. So far there is very little evidence of a pass-through of inflation in Europe. But as long as the headline-to-core rate of inflation gap remains, expect the ECB to pound the market with anti-inflation rhetoric. At the moment it is concerned with the ongoing round of wage negotiations.

The ECB still may not be happy with these developments. Surely it is still wary of the strong increases in commodity prices and the strong growth in European money and credit aggregates. But German, Italian and Spanish inflation rates have come lower. Only France in this group has some mild inflation that may be taking hold. Ultimately this will undermine the ability of the French president and his finance minister to carp at the ECB. To the extent that France has tried to go its own way to and to pressure the ECB to support stronger growth, the French fiscal and domestic policy stance reveals inflation trends that remind us why the ECB should NOT be hostage to or influenced by national desires. Politicians usually have one objective: stronger growth. If it can be accompanied by low inflation, that’s fine. But for politicians it is not a goal. Yet they are the first to complain when inflation gets stoked and central banks must hike rates in response.

Only in Germany and a handful of other countries, do we find governments that persistently understand the importance of keeping inflation down and that do not try to jawbone the central bank. The ECB has its priorities straight: protect against inflation first and resist pressure. Now all we need is to get France’s Sarkozy to see the merits in this approach and maybe the ECB can be even more effective. There is nothing like having someone of influence chewing away at your independence to undermine it. What we see amid this potential inflation bubble is how well the ECB has acquitted itself so far despite the pitfalls and the pressures… We can be optimistic for the time being but the game is still engaged; it’s too soon to declare a victory.

Trends in HICP
  % mo/mo % saar
  Jan-08 Dec-07 Nov-07 3-Mo 6-Mo 12-Mo Yr Ago
EMU-13 0.3% 0.2% 0.7% 4.8% 4.2% 3.2% 1.9%
Core 0.1% 0.2% 0.3% 2.5% 2.7% 2.3% 1.8%
Goods -0.5% 0.1% 1.0% 2.0% 4.8% 3.7% 1.5%
Services -0.2% 0.9% -0.1% 2.4% 0.4% 2.5% 2.3%
Germany 0.3% -0.2% 1.0% 4.3% 3.7% 3.0% 1.8%
France 0.3% 0.4% 0.7% 5.9% 4.6% 3.2% 1.4%
Italy 0.1% 0.4% 0.4% 3.5% 3.9% 3.1% 1.9%
Spain 0.2% 0.5% 0.8% 6.5% 5.8% 4.4% 2.5%
Core: xFE&A              
Germany -0.2% 0.3% 0.4% 1.9% 2.0% 2.1% 1.8%
France 0.3% 0.3% 0.3% 3.5% 3.1% 2.2% 1.4%
Italy 0.0% 0.3% 0.2% 1.9% 2.7% 2.5% 1.6%
Spain 0.2% 0.3% 0.3% 3.3% 4.1% 3.2% 2.7%
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