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Economy in Brief

EMU Inflation and European Vehicle Sales
by Robert Brusca  March 16, 2017

Two important reports are on tap today. One is the finalization of the HICP data and the new availability of core HICP data for the EMU and key EMU members. The second is vehicle registration in the EMU which are slowing. The key trends in vehicle registrations are slowing on a broad front in the EU as everyone is looking for faster growth, making it a bigger deal as a report. As for inflation, EMU inflation is accelerating sharply, but core inflation is not. Spain and Germany lead the pace (among top four EMU economies by size) in terms of the speed of the HICP rise and in terms of the pace of the core. But only Germany and Spain have core inflation gains that exceed 2% over three months and only Germany has a 2% pace in place over six months. Germany also has the highest core pace for year-on-year inflation at 1.7%, much faster than the next closest member (here that is Spain at 1.0%).

Ongoing policy tension over inflation
The tension in the EMU is palpable. The Germans want rates to go up and Draghi is playing for more time to let the sense of recovery that hangs in the air, have a time to breathe, and lay down roots. It is not clear if that will happen and neither it is clear that the ECB is behind the curve in fighting inflation as the Germans fear. But as the EMU economy with the lowest unemployment rate in the EMU, we should not be surprised to find Germany with the most severe inflation problem. It is the EMU economy with the least slack. Of course, Germany's situation calls for a rate hike by traditional German rules.

Policy is about the needs of the union
Germany is in a currency union and it must respect the needs of the union. While Germany may think it needs a rate hike, that is not what the EMU needs. However, the EMU wide HICP is flaring as badly or worse than the German headline for inflation at least on some measures. But Draghi has been dismissive of headline inflation since it is being driven so much by oil. At a time like this, a look beyond oil makes sense. And the core produces such a look. The HICP core is up by much less than the headline at only a 0.9% pace. But the German core is up at nearly double that pace at 1.7%. Among France, Italy and Spain, the highest core year-on-year is Spain's 1% gain with Italy at 0.6% and France at 0.2%.

Overall inflation and its acceleration
In trying to decide who is right and what is going on with inflation at all levels, it is instructive to look at 12-month inflation now vs. what it was one year ago. In February 2016, the EMU HICP was not even rising; it was falling at a 0.1% annual rate. Here just 12 months later, it is rising at a 2% pace and is within the HICP limit or even a touch too strong since the ECB shoots for inflation of slightly less than 2%. On the same timeline, Germany has done worse with 12-month HICP at 2.2%, up from declining at -0.2% annual rate one year ago. Germany and France have have slightly more tepid accelerations, but Spain's acceleration has been much more severe with inflation rising by 3.1% over 12 months now compared to dropping by 0.9% one year ago. Spain's acceleration is at a 4% annual rate. And that is impressively worrisome.

The core shows the reason for Draghi's patience
However, if we look at core inflation, a different story emerges altogether. There the EMU core rate at 0.9% has only barely accelerated from its 0.8% pace of 12-months ago. Germany still has a more impressive acceleration with a core at 1.7%, up from 1% a year ago. In Italy, core inflation has not budged; its pace is stuck at 0.6%. In France, the core inflation rate has fallen from 0.6% a year ago to +0.2% currently. Spain's core inflation is up to a 1% pace from 0.8% a year ago.

Where inflation resides
While Spain has made a lot of inflation progress compared to the way it used to be, it still seems to have some of that old inclination to let inflation transmit in too easily. This is apparent from the pace of the headline and from the height and speed and of the HICP's pace of increase. But Italy and France seem much more core inflation resistant. On this comparison, Germany seems to stand alone as a country with an inflation problem stemming from its own overheated economy and succumbing to oil induced inflation. Germany has the lowest unemployment rate in the EMU and so it is not surprising that it cooks up fast in a game of inflation. Inflation really doesn't look like it is truly accelerating in the zone as a whole. Core inflation, for the most part, looks as though it has been inoculated against a rise in the headline except in Germany.

Trends in vehicle registrations
Vehicle registrations are down in February, dropping by 3.8% month-to-month in Europe. Registrations are only up by 0.8% year-on-year. Registrations in February are lower in four of the five countries for which we have separate information. Only Italy has registrations higher in February month-to-month and Italy is also the only country with any substantial year-on-year gains. Spain has registrations up by 0.1% over 12 months, the U.K. has registrations lower by 0.7%, in France registrations are lower by 1.3% while German registrations are lower by 2.8%.

Sales slow in the U.S. too
This is a more common story than you might imagine. The U.S. shares some of these characteristics. U.S. core inflation is showing a bit more pressure than in the EMU as a whole. But vehicle sales in the U.S. that have driven consumer spending in recovery may now find slower going. Sales already have slowed. Now subprime U.S. auto loans are running into problems. Loan losses are rising sharply; the value of repossessed cars is not covering the balance due on the loans. With rates rising, auto financing could become much more expensive and U.S. sales could slow more substantially as well.

Central banks on a hot tin roof
Ironically, just as markets are getting hyped up about improved growth prospects, we see some real flies beginning to appear in the ointment. The Fed is now on a program of rate hikes and two more hikes are 'scheduled' for later this year by the data-dependent Fed. The BOE today had its first policy dissent in while as one member looks to hike rates now. The ECB continues to fight its tug of war internally with Germany wanting rates to go higher. Japan is holding the line on its stimulus as are the Swiss.

While there have been some stronger economic reports such as the PMIs (another strong reading in the U.S. today from the Philadelphia Fed manufacturing survey), it is also true that traditional reports have not gone along with that signal. U.S. retail sales released yesterday were so spotty that the Atlanta Fed has cut its estimate of unfolding U.S. GDP (GDP Nowcast) for real growth to an annual rate gain of 0.9% in Q1; yet, the Fed went ahead and hiked rates anyway. Recently German industrial orders and industrial output have been weak and for Europe manufacturing output (y/y declined). We do not yet have smooth sailing for a rate hike or for a program of ongoing rates hike anywhere not even in the U.S. But in the U.S. that ship is under sail. The Fed continues to step out on thin ice to make its vision happen. What is different this year than in the past is that the Fed is willing to take the risk and does not go back at the sound of cracking ice. That cracking sound doesn't mean that the Fed won't be able to continue on that path, but it makes it a dodgier bet.

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