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Economy in Brief

BUBA on a Hot Tin Roof
by Robert Brusca  March 2, 2017

Inflation in the EMU, in any of its largest four economies, overall inflation, core inflation, or in Germany, inflation excluding energy is accelerating. The 12-month pace exceeds the previous year's 12-month pace, the six-month pace exceeds the 12-month pace and the three-month pace exceeds the six-month pace... everywhere. The conclusion of acceleration is inescapable and broad, not episodic or narrow. Still, the ECB is expected to stay on hold and the Bundesbank is not a happy camper.

Why Germany is overwrought
These circumstances have the Bundesbank officials most distraught as German inflation is over the top. Of course, there are no formal country-level inflation targets. But in Germany the headline pace is 2.2% over 12 months, compared to the EMU-wide 2% pace. The German ex-energy pace is at 1.7%, compared to 0.9% for the core all of the EMU. Germany is experiencing more inflation than it would be tolerating on low and unchanged interest rates if the Bundesbank were running the show. But the Bundesbank is not running the show.

Running monetary policy
Monetary policy is being run for the EMU area as a whole by the ECB and for that region at 2% headline inflation is only a pinch higher than its 'just a bit less than 2%' mandate. But with the core rate below 1% and only at 1% when the pace is compounded over a three-month period, it is hard to argue that this is anything but a one-time pass-through of oil prices. German import prices today ratcheted up at their fastest pace in six years. Clearly, Germany is feeling the brunt of the inflation pressure. But that makes sense as the country with the lowest rate of unemployment in the EMU. Germany is certainly the most inflation prone of EMU economies, at least it would be were we to evaluate each one by Keynesian principles. Germany has less slack in the labor market than any other country in the EMU although the German people have one of the lowest inflation psychology dispositions in Europe as a counter-weight.

The EMU unemployment rate parade marches to different drummers
The German economy has a 3.8% rate of unemployment, a new reunification low. Belgium has the second-lowest-ranking queue standing for its unemployment rate among the original EMU members. The Belgian unemployment rate has been lower only about one third of the time since January 1991. Ireland's rate has been lower about 37% of the time. The Dutch and Finnish rates have been lower about 43% of the time. And the rest of the original EMU members (7 other members) show unemployment rates that are still above their medians implying a good deal more slack in their labor markets. Only Germany is in a position to be experiencing labor market tightness. That's why it is not surprising that its inflation rate is rising relatively more rapidly than elsewhere. Portugal, Spain, Italy and France still report unemployment rates in double digits. There are four and nearly five of the original 11 EMU member countries with unemployment rates three times higher than Germany's. However, all EMU nations except Italy and the Netherlands are still experiencing year-over-year declines in their respective rates of unemployment. Spain with the highest unemployment rate is seeing the largest drop, but Greece with the second highest rate is seeing only the fourth largest drop among the original members. And Italy with the fourth highest unemployment rate is seeing its rate increase.

One monetary policy to rule them all...and in the dark to bind them?
The level and movements of the unemployment rates do not make it easy for the ECB to make policy choices although for the bulk of EMU the policy need is clear. There is still a lot of economic slack, the core rate is still low and it is barely accelerating and since there is still substantial labor market slack there is space for the ECB to take its time about letting this bump up in oil prices run its course. Germany left on its own would want a rate hike. Italy left on its own would want even more stimulus. But this is Three-Musketeers-type monetary policy one for all and all for one!

Let's see what condition my condition is in...
For now the EMU and the U.S. seem to be in about the same position in some ways. At least in the U.S. headline inflation is high but the core remains muted and without much momentum and below target as it is in the EMU. The U.S. is more like Germany than like the EMU in terms of its unemployment condition. It has a historically low rate of unemployment but a still under-target core inflation reading. The U.S. is different from Europe altogether in that the U.S. central bank is a few steps down the road, ahead of the ECB as it is tightening and the ECB is still locked in a full accommodation mode. But the monetary policy environments still have a lot in common on the inflation front. What is different and very different is the fiscal background with the new Trump administration bristling to get fiscal stimulus in gear while Germany and the EU Commission remain strong enforcers of the EU Commission's debt and deficit rules that have ruled the roost in Europe for the past decade come Hell or high water and there has been some of each.

What markets expect
Markets have been anticipating the Fed getting to the much less accommodative point of the policy cycle ahead of the ECB. Of course, technically it did so a while ago, but with a premature move that the Fed was not able to follow up on. Now it appears that a real tightening cycle may be in sight. Despite not having much inflation, the U.S. has low unemployment and it has a more stimulative fiscal policy in prospect (well that's two out of three). That seems to be all the Fed requires to put its tightening program in gear. That view is beginning to play out in markets especially regarding the dollar. And as the Fed gets its policy in gear, we can expect to have some global fallout from it. It is a good time to fasten you safety belt, and to recalibrate your portfolio. Change is in the air and this time it looks like it is real. Lucy will not be pulling away this football at the last minute. A real tightening cycle is about to kick-off.

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