Euro-Area Revises Inflation Is Higher

So long as the ECB insists on looking at headline inflation, the picture in the chart above is going to continue to haunt it in its sleep. While headline inflation is ‘raging’ that has almost nothing to do with monetary policy. Monetary policy cannot impact severely rising commodity prices except over a period a time. The headline for inflation is going to do what it is going to do based upon the weights that define it. But when prices rise on items with relatively inelastic demand like energy and food and some raw materials with no real short term substitutes the situation is exacerbated. To put that toothpaste back in the tube takes some time. A steady non-accommodative policy can do it or the central bank can be more aggressive and hike rates, as the ECB has done.

We see this immediately in the table below that shows core inflation across the Zone. In EMU itself core inflation is up only by 1.5% Yr/Yr. That compares to a headline rise of 2.7%, nearly twice as much. With such uneven economic conditions in the Zone, the ECB could have waited to hike rates and had mercy on some of its weaker members but it has chosen not to do that and now a stronger foreign exchange rate for the euro will be another disciplining factor that weak euro-members will have to try to contend with. It’s as though ECB is looking at headline inflation Yr/Yr and core inflation over three-months to see the kind of risk it seems to be responding to.

Year-over-year core trends - As the Core inflation table shows Core inflation is generally much better behaved than the headline and shows a great deal of variability across EMU/EU members. Greece shows none of the weakness in inflation despite the fact that it is one of the weakest EMU nations shows the highest core inflation rate at 2.9% But looks can be deceiving, that inflation rate in Greece has been falling. Its core has been as high as 3.7% back in October and the current 2.9% reflects progress. Portugal has austerity in train and is about to be subjected to more yet its core inflation rate just hopped up to 2.3% from 1.9%. Luxembourg one of the smallest EMU members has shown excess core inflation over the past three months. Ireland another troubled EMU nation has seen negative core inflation for many months but its core rate has been steadily showing less downward pressure. The large economies of France and Germany show core inflation of barely half the ECB’s headline cap-rate with Germany at 1.2% and France at 1%. Spain’s rate has edged up to 1.7%.

Three-month core trends - Spain, Portugal, and Austria show surging rates of Core inflation over three-months. But Spain and Postural are slowing economies. It hardly seems likely that their inflation will continue to run. Greece is almost back under control with its Core HICP up at a 2.1% pace over three-months. Over three-months inflation rates have made appreciable acceleration everywhere in this table except in France, Finland and Germany.

In this presentation it both easy to see what the ECB responded and to see why there were also strong arguments to wait. The US is about on the same inflation curve as Germany for Core inflation but it still lags behind the Zone. With the Fed looking more at the core inflation rate than at the headline rate, and still in an accommodative mood, we may see more dissension in the Fed’s next meeting. Whether the ECB or the US proves to have had the better monetary policy probably will depend on what oil prices do from here forward.