Inflation Trouble in Euro-land

Inflation in the euro area rose sharply again in July, bringing the year-over-year pace to 8.9% compared to a 12-month pace of 8.6% for June. Inflation is running at a pace that is multiples of the European Central Bank’s target of 2%. However, the ECB has finally started to raise rates and, as we showed in a previous research piece, there is a more pronounced inflation-damping impact in train from the slowdown in money supply growth in Europe, which may also be eventually having some impact on the inflation rate.

For now, inflation is still running out of control. In July, the headline inflation accelerated in Germany compared to the gain in June but decelerated in France, Italy, and Spain.

Over three months inflation is decelerating in Germany and in France; it's accelerating in Italy and in Spain. German inflation rises at an 8.4% annual rate over 12 months, at 9.2% pace over six months and falls back to 6.3% over three months. In France, the progression is from 6.8% over 12 months, up to 9.3% over six months and down to 8.4% over three months. Italy and Spain show acceleration across all horizons. In Italy, the 12-month gain of 8.3% moves up to an 11.3% pace over three months. In Spain, the 10.8 percent 12-month pace moves up to a 15.2% annual rate over three months.

In three of four cases, excepting Germany, the three-month inflation rate remains higher than the 12-month inflation rate. In Germany, the three-month rate has dropped to a 6.3% pace from 8.4% over 12 months, a potentially significant drop. In France, the 3-month-to-12-month acceleration is over one and a half percentage points. In Italy, it's three percentage points; in Spain, it's on the order of four and a half percentage points. Inflation for the whole of the European Monetary Union accelerates from 12-months to three-months with a three-month pace about one percentage point stronger than the 12-month pace.

Ex-energy/core trends In Germany, ex-energy inflation gains 4.4% over 12 months, accelerates to a 5.1% annual rate over six months then falls back to a 4% pace over three months The German ex-energy inflation pace, like the German headline pace, is weaker over three months than over 12 months. In Italy, core inflation steadily accelerates from 4.2% over 12 months to 5.6% over six months to 7.7% over three months. The core rate in Italy over three months is higher by about 3.5 percentage points than the 12-month pace – a bit more acceleration than for the headline.

Between June and July, the 12-month inflation rate also stepped up to 8.9% for all EMU from 8.6% in June. The country level inflation rates saw Germany’s rate rise to 8.4% from 8.3%; the French rate rose to 6.8% from 6.5%; the rate in Spain rose to 10.8% from 10% in June. However, in Italy, the inflation rate settled lower at 8.3% in July compared to a rise of 8.5% in June. Germany’s ex-energy inflation rate accelerated in July to 4.4% from 4% in June. The Italian core inflation rate was unchanged between June and July at a pace of 4.2%.

Energy prices for Brent expressed in terms of euros saw a 3.8% decline in July after rising 23.1% in June and by 9.6% in May. The acceleration pace from 12-months to six-months to three-months are still impressively large.

The ramp up in inflation has brought the HICP up to a stunningly high – previously unthinkable- level in July. However, the year-over-year rate has not been this high for that long. In January, it was as low as 5.1%; in July 2021, just a year ago, its pace was a barely excessive 2.2%. As an example, the five-year compounded inflation rate for the EMU is at 2.9%. For Germany, it's at 3%; for France, it's at 2.6%. In Italy, the five-year compounded rate is at 2.4% while in Spain it’s at 3.1%. Much of this is because of the volatile items in the report mainly food and energy, particularly energy. If we look at the five-year compounded German ex-energy rate it is still only at 2.1%. A year ago, inflation was still at a level that was consistent with the target rate set by the European Central Bank for the whole of the euro area. Italy's five-year compounded core inflation rate is at 1.3%, still below the pace targeted for all the euro area.

This period of excessive inflation comes after a period of substantial price stability. However, inflation has clearly gotten beyond control and a lot of it had to do with the impact of the COVID virus on economic activity and on policymakers’ response to that pandemic. The pandemic also had real economic effects reducing labor force participation rates, creating premature deaths on the part of a number of citizens and former workers, as well as interrupting supply lines, in some cases irreparably. COVID continues to linger in a different, less dangerous form. However, it's still a factor in a number of countries. And the new scourge is Russia's war in Ukraine which is exacerbating pressures on energy prices and food prices as well as other raw materials and for number of now hard-to-find inputs.

Europe's monetary acceleration has begun to unwind, and the ECB has started to raise interest rates; there are remedies in train. But there is also a horrifically high inflation rate to deal with. The ECB is put in a very difficult position because as much as some members want to move strongly to push inflation back down, Europe's energy supplies are threatened by Russia that has already cut supplies off to a trickle. The risk of recession in Europe is palpable and yet monetary tightening is necessary. Europe and the ECB find themselves at a very difficult spot.