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Economy in Brief

PPI Inflation Soars in EMU Mostly on Intermediate Goods
by Robert Brusca  August 3, 2021

Inflation in Europe continues to turn up sharply at least at the PPI level. In June the monthly PPI gain was 1.5%, up from 1.3% in May. In fact, over three months the EMU PPI is accelerating a bit faster than it does over six months. And both are much stronger gains than over 12 months. Acceleration is still the rule of law here.

Brent oil prices slowed but still rose briskly in June, gaining 7.8% after rising by just 4.4% in May. Brent oil prices are up by 80.3% over 12 months, 112.5% over six months (annualized) and at a slower but still hot annual rate of 58% over three months. Oil still seems to be driving PPI prices.

Table 1

Among the 14 countries in the table only the Irish PPI rose by less than 1% in June. In May, France, Luxembourg, and Greece say their respective PPI’s rise by less than 1%. The pricing heat is broad. However, the R-squared correlation between Brent oil and various PPI sectors shows that manufacturing prices overall have an R-squared relationship above 0.6 while only intermediate goods have an R-square close to 0.5 (0.46). For consumer goods the R-square is 0.23 and for capital goods it is 0.023. Turning to consumer prices, the HICP has an R-square relationship with Brent close to 0.5 but the HICP core is only at 0.024.

Table 2: Brent Correlations

However, PPI accelerations are still rampant in Europe. In June month-to-month, 71% of countries saw prices accelerate. Over three months the acceleration is down to 50%, but that is only in the wake of 100% acceleration over six months and 100% acceleration over 12 months.

The chart on sector inflation shows price inflation rising by sector but with the strongest increases in intermediate goods by fare. Intermediate goods accelerate from a gain of over 10% over 12 months to 19% over six months and 22% over three months. Inflation rates also double for consumer goods and capital goods. For capital goods, it is from 2% over 12 months to over 4% over three months. For consumer goods, it is from 2.4% over 12 months to over 5% over three months.

The increases of consumer and capital goods are small but proportionately large. So on one hand it seems that inflation is mostly a matter of intermediate goods where the correlations with oil are large, but beyond that, there is another stubborn acceleration in progress.

Table 3 below run data over the same countries as in Table 1 across the three main sectors. The table reports out the median for each sector and its diffusion (tendency for inflation to rise over one period compared to another).

The diffusion tallies show that consumer and capital goods price pressure are cooling across the recent three-months where diffusion values dip below 50% showing that there is mote inflation deceleration than acceleration. For intermediate goods prices are showing pressure with all diffusion values about 50% although only one of the three-months has a truly high diffusion value.

Sequential growth rates are comparing median inflation over adjacent horizons: three-months to six-months; six-months to 12-months; and, 12-months to a year-ago. These comparisons show diffusion values that are still quite high for all sectors across countries. While diffusion readings have come down over three months, none of them can really be regarded as comfortably tame.

Table 3: Sector Medians

The great inflation debate
There is a debate about inflation. Some of the inflation is oil-related. But some of it is still fallout from the pandemic and getting back to work along with lingering supply chain issues that have created shortages and price pressures. When shortages occur, and when production cannot ramp up to eliminate them, delivery lags extend order back-logs pile up, and prices rise to ration the scare goods and to restore order to markets. However, high prices and rising inflation that results is not considered ‘orderly’ by central banks. Still, most central bankers act as though these pressures that we are experiencing and that look like classical Keynesian bottleneck inflation, are temporary and will dissolve in time. And when we catch our central bankers talking at an unguarded moment, they sometimes let it slip that these price pressures may linger for a relatively long period of time.

Is lingering inflation still inflationary?
The question really this: are such lingering pressures merely lingering pressures or are they are just another name for real inflation that central bankers simply do not want to have to deal with under current circumstances. If price increases are persistent over time, they will become part of business and consumer psyche – whatever you call them (In other words, would garbage by any other name smell as foul?). And all the work done to get inflation low and keep it there over past decades will be undone unless there is vigilance. Central bankers are aware of this and so they claim to be looking at inflation expectations. Expectations are climbing higher just about everywhere, but here again central bankers call the increases consistent with current price targets… even if they aren’t.

Realty bites..or worse
However, if we decide to deal with practicality, while I would not say expectations are not relevant, I would point out that expectations do NOT do a good job of forecasting future inflation. All the talk about keeping expectations in check is more from a ‘theoretical standpoint’ because we know that even if that is done inflation could turn out to be very different from what expectations for it are today. However, what is important for prices and pricing is actual behavior – pricing behavior. And once upon a time, inflation was so low and stable across the board and across industries that businesses were reluctant to raise prices because they did not want to lose market share. This behavior is now lost as all prices are rising and costs are rising and price disciple is being lost day by day.

Is price stability slipping away?
How do we get back to price discipline if inflation is going to continue to be stubborn at high levels or even rise? I think that we do not. Failure to raise interest rates now, failure to address what is clearly inflation, will be something for which another price will be paid - eventually. The ECB is still in control of its inflation rate in HICP terms despite the pressures we chronicle here in the PPI. The HICP is only now drifting above the former ‘ceiling.’ Prices in Europe could be called fine and consistent with the new ECB plan because of the new averaging process that is being used. It is not even under strain at the moment… But in the U.S., inflation is out of control and while it will probably get somewhat better on its own, there is not much chance that it will restore the sort of stable price environment and price discipline the U.S. once had. Not only has the monetary framework been shattered, but the political pressures and the fiscal picture are vastly different and worse. No one even wants to talk about that. Yet, monetary policy has rarely been made well when central banks go off and play a game of let’s pretend. And that is where they are headed. For a while, markets will ‘pretend’ along with them and then that game will end, ingloriously.

Commentaries are the opinions of the author and do not reflect the views of Haver Analytics.
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