Inflation in EMU Accelerates…Despite This Chart…

EMU inflation (month-to-month annualized) advanced at a 7.5% annual rate in August, up from a 5.7% pace in July. The year-on-year pace is at 4.2%. Countries showing the year-on-year pace of inflation faster than the overall EMU pace monthly are France, Germany, Italy, Portugal, and Ireland.

Inflation HAS broadly decelerated Inflation broadly decelerates over 12 months compared to its pace of 12-months ago. Every country in the table shows deceleration on this basis. The deceleration of inflation on this basis is -5.7 percentage points for the EMU overall; the median deceleration across members in the table is -6.1 percentage points. The greatest deceleration on this timeline is the -16.5 percentage-point drop off in the Netherlands, followed by a -11.1 percentage-point drop in Belgium, and a -10.5 percentage-point drop in Greece.

Compared to a year ago, the drop of in inflation is terrifically large. But that now seems to be a trend of the past that is withering.

The road ahead has more twists and turns Economists warn that the hard part of inflation reduction lies ahead. When oil prices fall, they can unwind inflation substantially, broadly, and quickly. But once inflation has been high for a while, other prices begin to trend with it and the higher inflation rate becomes entrenched. A dropping inflation rate is good news; however, at some point, the pace of inflation needs to be the focus rather than just the change in the pace. The focus on other prices that become sticky if inflation lingers too high for too long, is usually a spotlight on wages, since labor seeks to get back the compensation it loses when inflation rises. So, wage gains rise at a faster pace and then policy is pushing to reduce both wage and price inflation.

Inflation progress is slowing…down…does anyone care? Over six months, prices decelerate in the EMU by -0.9% at an annual rate compared to their 12-month pace. But deceleration only occurs for five of the twelve economies in the table (the EMU pace represents all EMU countries and is formed using weights reflecting the size of member economies). The median deceleration for 6-months compared to 12-months for reporting members in the table is not for a deceleration at all but for an acceleration of 2.7 percentage points.

Over 3 months, EMU inflation rises to 5.2% annualized from 3.3% over six months, an acceleration of 1.9 percentage points. Among table members, there is, nonetheless, an average deceleration of 0.3 percentage points (annualized). That would become 1.2 percentage points if the pace held for one year. Over 3 months, six of twelve members show deceleration.

So... Is this the right time for central banks to slow their pace of tightening? The bottom line on this is that central banks are slowing their pace of rate hikes as they look back at the enormous inflation progress, they have made. But in the EMU, the 12-month pace of inflation at 4.2% is still well above what it targets (2%). And the three-month annualized pace is even faster. Moreover, the annualized percentage changes month-to-month for each of the last three months produces gains broadly in excess of the ECB target. Among this pool of eleven countries over the last 3 months (33 observations month-to-month), only seven of thirty-three month-to-month annualized inflation readings are at or below the ECB’s 2% target pace– that is only a 21% success rate among the observations.

Trends can be misleading and misread Recent trends do not favor the view that inflation progress is still strongly in gear. Year-over-year inflation calculated on a monthly frequency has declined steadily for 10 months in a row. Central banks tend to look at year-over-year trends and distrust the shorter calculations because the shorter trends are more volatile. That means central bankers are- and will continue to- look at trends that look quite good to them in terms of continuing inflation progress. However, the evidence on the margin is that inflation progress is slowing down. We can’t even guarantee that it will remain in gear as a slowdown. There could be backtracking. If central banks also put rate hike programs on pause, they could cause inflation to become more entrenched at current levels and bankers may have to raise rates more significantly and do it sooner than they would like to return inflation to target in the months ahead.