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Economy in Brief

EMU Inflation Trends Stay Hot
by Robert Brusca  March 17, 2022

Inflation in the European Monetary Union (EMU) rose by 0.7% in February after rising by 1.1% in January. The core measure for inflation (excluding food and energy) in February rose by just 0.1%; that was after rising by 0.7% in January. Sequential growth rates that measure inflation over 12 months, six months and three months show inflation has been building momentum for the headline inflation rate which expanded by 5.8% over 12 months, at a 7.9% annual rate over six months and at an 8.9% annual rate over three months.

The core rate of Inflation breaks this string of acceleration but only technically. The 12-month core gain is at 2.6%; that rises to a 3.9% annual rate over six months and that in turn backs off very slightly to log a technically smaller gain at a pace of 3.8% over three months. Essentially inflation has gone from being excessive over 12 months to being much more excessive over three months and six months according to each of these measures.

The ECB is well away from its target of hitting 2% inflation although as we're going to see in the averages for inflation how much better-behaved much of this inflation phenomenon is when averaged. Inflation has really welled up relatively recently although it's quite excessive and now it still has momentum.

Moreover, inflation is gaining momentum and from different sources. Oil prices are still extremely high in February. But Brent oil prices measured in euros fell 28.2% in February after rising by 14% in January. Oil prices remain high and the impact on inflation is still something to worry about because in global markets oil continues to hover at very high levels. Also, Europe has an economic 'IV' line for energy that is piped in from Russia making it dependent on the very country on which they have slapped aggressive economic sanctions. And to follow that thought… since Russia is walled off from global markets by sanctions, at some point it may find oil revenues as not as valuable as cutting off the oil flow and inflicting economic pain on Europe.

In several ways the war in Ukraine is a factor...

Before the war welled up, there were supply chain problems created by the pandemic (remember the pandemic?) and these supply chain issues were affecting prices globally, creating shortages, creating price pressures, and that now is made worse by having a war in Ukraine and having these countervailing sanctions placed on Russia.

Russia is rich in natural resources and with the West putting sanctions on Russia, Russian commodities are going to be unavailable to the world and this is going to be reflected in higher commodity prices. The invasion of Ukraine is taking Ukraine off the map as an international trading partner and that of course is going to hit the food market and wheat market particularly hard as well as the market for selected natural resources. The implication here is that inflation is high, inflation has momentum, and inflation has some new sources that are going to make it worse before things get better.

This is not the scenario central banks wanted to face. But this is the scenario that central banks will have to deal with. At this time, we've got central banks moving, tightening policies in various ways globally. The Federal Reserve has just raised rates and set out a program of rate hikes. The Bank of England has made its third rate-hike. Monetary policy is set in motion and it's not clear whether it can be successful against this kind of inflation which is essentially an inflation borne of supply chain shortages of wartime pressures and not so much because of excessive money or credit expansion. Money and credit growth in the EMU did respond early in the pandemic, but credit in particular shows no surge to explain the sudden rise in inflation.

Table 1 includes inflation measured by country and core (or ex energy inflation) as well as headline inflation. Measures are provided for Germany, France, Italy, and Spain the four largest economies in the European Monetary Union. There is the steady acceleration of inflation from 12-months to six-months to three-months for each country, for each measure, with one single exception and that's Germany. In Germany the three-month inflation rate at 7.4% declines from 7.8% over six months after running at 5.5% over 12 months. So even with that exception what is clear is that inflation is high, inflation is accelerating, inflation is higher over three months than over 12 months everywhere. And inflation continues to be a problem both for headline and for core measures in the monetary area.

Table 1

We present Table 2 because the European monetary union has moved to looking at 'some kind of average' inflation targeting. Like with the Fed they won't tell us what it is so we don't know what we should look at. But we know that the ECB is looking at some form of average inflation targeting. And we don't even know what it means as to how they're going to use the average to set interest rates. Policy conduct remains a guessing game. So, the table that I have included here shows inflation over 12 months, two years, three years and four years as well as a discreet calculation of inflation over four years. The discrete calculation looks at inflation over 4-nonoverlapping but consecutive years (12-month periods). The other measures over 12 months and two years, three years and four years are averages over those periods of year-over-year inflation monthly.

What these averages show is that inflation is above the 2% objective of the ECB when averaged over 12 months but it's below the 2% mark when measured over two years, three years, and four years although not for the discrete measure over four years; that measure is at 2.3%. Core inflation is low on all the metrics at 1.7% for its 12-month average of year-over-year inflation. Looking at inflation by country, the HICP measures for Germany, France, Italy, and Spain range from a low of 2.7% for Italy to a high of 4.1% for Spain and a 3.8% pace for Germany. Looked at over two years, the German rate is above 2% at 2.1% and all the other rates are below 2%. Looking at the core excluding food and energy or just for the German looking at inflation excluding energy, the current inflation rate over 12 months is 2.7% in Germany, 1.4% in France, 0.8% in Italy and 1.1% in Spain. Core inflation is well-behaved everywhere on all these metrics except in Germany where we look at the German inflation rate excluding energy.

Table 2

On balance, inflation across the euro area is high, it's broad, and it seems to be entrenched. However, the averages show us that the turn up in inflation is a relatively new phenomenon. That still doesn't tell us how long lasting it's going to be. Because of supply chain problems, we would expect inflation to be somewhat longer-lived; it will take some time for these problems to be physically resolved. Because of the war in Ukraine, there's going to be an extra push. And because there are restrictions placed on Russia, we will have continuing tightness in the oil markets globally. There are number of inflation sources that look to be sticky in terms of what policymakers are going to have to deal with. This makes the job of trying to keep inflation from spreading very difficult. Because in this environment it appears that inflation really does not have a monetary source; it's not from excessive money growth; it's not from excessive credit growth; it's from the supply disruptions which monetary policy can't heal. Yet, monetary policy is going to try to do it. It can try to keep inflation from sticking around to keep wage price spirals from developing, and to push inflation back down where belongs once the supply conditions normalize.

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