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Economy in Brief

French Inflation Soars; HICP Gain Exceeds Domestic Measure...Is the ECB on Track?
by Robert Brusca  November 16, 2021

French inflation is flaring. It's a common theme internationally these days. The EMU HICP measure is up by 3.2% over 12 months and accelerates from there to a 3.7% pace over six months and to a 4.5% pace over three months. In contrast, the domestic measure is up by 2.6% over 12 months, accelerates to 3.1% over six months then ticks higher to 3.2% over three months. France's CPI excluding energy is even less fearsome at a 1.2% gain over 12 months, a 1.7% pace of increase over six months and a 2.3% pace over three months.

French inflation is up sharply from its pace of a year ago. One year ago, the HICP's 12-month gain was 0.1%. The domestic CPI was unchanged over 12 months and ex-energy the domestic CPI rose by 0.8%. So that is the base for this year's 12-month calculations.

Over 12 months French inflation is rising in 72.7% of the categories. Over six months the result is the same; inflation accelerates in 72.7% of the categories. Since both of these are above 50%, they indicate that inflation is accelerating in more categories than it is decelerating. And over three months compared to six months, the rate of inflation is higher in 54.5% of categories. That still tilts toward acceleration, but it is by a thin margin. The French data suggest that inflation is not very explosive.

So, for France the breadth of inflation's acceleration and the gain in the overall index shows lessening of pressures. Over three months inflation does accelerate but by one tenth of one annualized percentage point overall as the ex-energy CPI rises to a 2.3% pace from a 1.7% pace over six months.

As the second largest euro area economy, France is proving to be a buffer against rising inflation pressures.

Of the eleven CPI categories, inflation in October fell or was unchanged month-to-month in five of them. Inflation rose by 0.1% month-to-month in three of them. Inflation rose by 0.3% in one category. That leaves just two categories to drive inflation higher overall. Rents & utilities and transportation are the two that do that with gains of 1.5% and 1.1% month-to-month, respectively. The price gains are led by energy-dependent sectors. Overall, the HICP rose by 0.5% on the month, the same as the domestic CPI measure.

In September, five month-to-month CPI changes were flat or lower. The domestic CPI fell by 0.1% and the HIPC gauge rose by 0.3%. Restaurants and transportations provided most of the inflation thrust in September. In fact, that has been a theme since transportation has led all categories higher over the last 12 months with a gain of 7.8% followed by rents & utilities at 6.4%, communications at 4.1%, alcohol at 3% and everything else at 2% or less. In France, inflation looks like a sector problem much more than it looks like an endemic inflation problem. Seven of 11 categories have inflation at the ECB's declared boundary pace or below.

Like the Federal Reserve in the U.S., the ECB has switched to an average inflation rate as a target at the 2% mark. The table below shows what inflation is in the four largest EMU member nations if we average the HICP over several horizons. On that basis, only Germany is (barely) in excess over 12 months and everyone is compliant over longer horizons. All these horizons are ‘my invention' since I have no idea what horizon or which calculation method for average inflation the ECB will use.

All this is in stark contrast to a current German inflation rate over 12 months at 4.6%, French inflation at 3.2%, Italian inflation at 3.2% and Spanish inflation at 5.4%. Over three months annualized inflation in Germany and Italy exceeds 5% and in Spain it exceeds 10%. But using averaging everything is copacetic.

What is the truth? Is inflation copacetic or peripatetic?

The truth is that all these calculations are fair, honest, and correct. But numbers have peculiarities. To illuminate that, I have presented a final column in the table below entitled 4-Yr Discrete. The other columns calculate average inflation for 12 months as the inflation rate for each on those months divided by 12. The rate of two years takes the rate for the last 24-months divided by 24 and so on. But the discrete calculation calculates inflation over the last 12-months, the next 12-months, the next 12-months and the next 12-months and divides that by four. It eliminates all the double counting and calculates endpoint to end inflation over the last four years. On this basis, inflation turns out to be higher, by 0.4 percentage points overall and by 0.3 to 0.4 percentage points by country except for Spain.

ECB's Inflation Targeting

Averaging as an escape from rules; an open door to discretion
When the central bank targets 2% inflation, it targets a number. When it targets a 2% average, it targets a statistic, and a statistic is not a number. A number is a fixed thing: 2=2. But a statistic will be variable and the actual result of inflation over any period may be deemed close enough to 2% or not according to discretion. If the target is 2% and the inflation result is different, we can see that difference immediately and know that there is a discretion process if there is any. But if 2% on average is a target and if the tenor for the test calculation is not given, what does that mean? If the averaging method is not given, what does that mean? In short, it means that the central bank has gained a lot of flexibility and like Houdini has extracted itself from a straitjacket and obtained freedom of discretion in policy. That can be either good or bad depending on how they use it. In the EMU, the notion was to have a straitjacket and to target inflation of just under 2% - a number. The switch to a statistic is very much away from the intent of the old Bundesbank model on which the ECB framework was built.

So, we now have central banks making policy and using discretion. One reason to have policy rules is to guide strongly or reduce discretion. From 2015-2018, the Fed in the U.S. found a way to use discretion calling its policy target ‘aspirational.' That gave it leave to ignore incoming inflation (and policy target misses) and to assert that their models showed they would hit inflation ahead. This gave the Fed the leeway it wanted to raise rates and lift them away from the zero bound. But from 2015 to end 2018, the Fed only hit or exceeded its policy target inflation rate about 13% of the time- a poor record. Now the Fed is ‘at it again' seeing massive inflation overshooting and yet showing conviction that the gain in inflation will be temporary. If the fed is wrong again so soon, its credibility will be in tatters.

So, will it be right? Or will this become another huge policy mistake? And then what about the ECB that only just began to fight for some policy wiggle room under Mario Draghi. It now has an explicit framework to allow it to ignore inflation that in the past would have had rates rising- and, in fact, interest rates are instead staying extraordinarily low in the EMU. The ECB seems to be leagues away from being the policy anchor it was meant to be.

The data from France make it look as though the discretion is being properly assessed in the EMU. But it is too soon to give out awards. The question really applies to all of the EMU (not just France) and also pertains to how this inflation overshoot will change business and market psychology about inflation and if it will affect price- and wage-setting behavior. It always takes some time to know that.

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