European Inflation Progress Prevaricates; Has Inflation Reached a ‘Glass’ Floor?

Inflation measured by the European Monetary Union’s HICP rose by 0.1% in May, a seemingly small amount, particularly after increases of 0.2% in March and in April. However, the year-over-year rate at 2.6% is higher than it was in April at 2.4%; the year-over-year inflation rate has actually risen even with that small increase in May! Disinflation progression, however, continues to be in train from 12-months to six-months to three-months, as 12-month inflation rises at a 2.6% annual rate, then barely steps up to 2.7% annualized over six months, before dropping back to 2% over three months. Over three months, the inflation rate is back to the ECB’s target. However, over 12 months, the 2.6% rate continues that string of excessive inflation numbers (now up to 35-months-nearly three continuous years) that the European Central Bank has been over target. With inflation backtracking on the month, this is the highest year-over-year inflation rate since January of this year.

Countries mostly show ongoing progress Results for the large economies in the monetary union continue to show inflation progress for the most part. There's persistent deceleration in France where the 12-month rate at 2.6% falls to 1.5% over three months. In Spain, there's a 3.8% 12-month inflation rate that deflates to 0.7% over three months. In Germany, the 2.8% inflation rate over 12 months moves up to 2.9% over six months and then hovers at 2.8% again over three months. Italy has the lowest year-over-year inflation rate of the bunch, but it shows acceleration with inflation of 0.8% over 12 months rising to a 2.2% annual rate over six months and then stepping up to a 2.3% annual rate over three months.

Core/ex-energy inflation still largely behaves... Italy's core inflation rate moves down on a consistent basis from 2.2% over 12 months to a 1.9% pace over six months to 1.7% annual rate over three months. In contrast, the German rate excluding energy is 2.7% over 12 months, down to 2.6% over six months and back up to 2.8% over three months, stuck in a very narrow range and still substantially above the target sought by the European Central Bank.

Meanwhile, back at the ranch...

Paying homage to the old spaghetti westerns we used to see on TV in the United States, there was a technique of showing an action scene and then peeling away at the end to check in to see how things were going ‘back at the ranch.’ Let's use that strategy now to leave behind the discussion of inflation and see what's going on with growth and the European Monetary Union.

Just-released German retail sales data show a decline of sales in April although car registrations have held up. The 12-months to 6-month to 3-month growth rates for German retail sales flirt from low growth of 1% over 12 months into a small negative number over three months at -0.3%. Adjusted to real terms, German retail sales excluding autos are showing small consistent declines over 12 months, three months and six months.

Elsewhere in Europe sales grow In the United Kingdom, real and nominal retail sales continue to grow. For the rest of Europe among Monetary Union members and non-members, conditions mostly show growth. Reporters in the table show positive 3-month growth rates and all, except Norway, show positive 6-month growth rates and also 12-month growth rates. Except for Norway, all the growth rates, including those from the U.K., show progressive improvement in retail sales growth from 12-months to 6-months to 3-months.

Sustaining growth into Q2 While there may be some bad news in the sense that inflation progress has stalled or moved into a minor backtracking mode, it doesn't look like growth in Europe is vitally dependent on a rate cut at the moment, although markets certainly are looking for one from the ECB. The quarter-to-date retail data are slightly more vacillating. The U.K. is showing real and nominal sales declines QTD. Germany is showing real and nominal sales declines as well. For the rest of Europe, there are increases being logged QTD except for Denmark that posts a 1.3% annual rate decline. These are data for the second quarter with one month of the quarterly data in hand.

Striking a balance All in all these are not bad statistics in any way. The backtracking of inflation on the month is minor. At the same time, retail sales growth largely seems to be keeping momentum. Germany is an exception, but then it's been weaker than the rest of Europe for some time so that's not really news. Perhaps the more disturbing element in this report is not inflation progress backtracking but the fact that progress appears to have hit some sort of a glass floor. As the growth rates for inflation for the various large member countries have moved down toward 2%, they stopped or slowed falling (except Italy that bottomed out at a lower pace); some of them show inflation has started increasing. Since 2% is the objective for policy and since the overshoot has been in play for quite a long time, it's important that the European Central Bank start hitting its target- sooner rather than later. If you can miss a target for three years running, and run a compounded rate of 3.7% over five years- what is the point of a target, let alone the value?

New standards for central bankers? Central bankers seemed to have changed their diet from what they were consuming in the 1980s when there was a real religion to stop inflation in its tracks. Now central banks seem to be content to allow inflation over the top of the target as long as they are able to convince themselves or others that they have interest rates high enough to gradually bring inflation back down and to get it to heel within their target area. This is certainly a change and none of these central banks resemble the ones that I worked for or used to follow closely when I was beginning my career an economist in the late-1970s. Something very clearly has changed. There was fire in the belly to reduce inflation from double-digits but only stomach acid over inflation above 2%. I'm not convinced that it's for the better even though central banks are trying to have a lighter touch on the unemployment rate. The old expression from child rearing used to be ‘spare the rod spoil the child.’ And I'm not sure that expression does not apply to central banks who are afraid to administer the proper medicine to bring inflation to heel ‘sooner.’ Long established trends in monetary policy show us that when inflation is brought down from a high rate and it isn't brought back down to it's previous lows the only thing that's going to happen is inflation is going to rise in the next cycle from a higher level and that's the kind of progression that brings us real inflation trouble in the future – circa the 1970s. Central banks need to recover their inflation fighting mojo and get back to 2%. Policy be at a crossroads. The longer inflation lingers above 2%, the less 2% looks like a real target; it begins to look ‘aspirational’ or like lip-service, not like real policy or like reality.