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Economy in Brief

EMU Inflation: Has the Worm Turned? Are The Pessimists Burned?
by Robert Brusca  July 14, 2021

It is impossible to look at the graph and then at the table beow and not see inflation at work. But is inflation still at work and headed for overtime or has it seen its day and is it on the wane? Is the inflation worm turned? Inflation is like that. It can seem to be omnipresent and then just as suddenly recede. Since the Great Recession, it has been hard to see any inflation trend globally. That is one of the reasons that this sudden and sharp emergence of inflation has been such a jolt. Most reserve currency central banks have been missing their inflation on the downside until this past year. Then suddenly after the virus receded, inflation appeared.

Pessimists say it was inevitable after all the deficit financing of enormous fiscal spending and a protracted period of monetary stimulus ranging from negative rates in some places to low rates and encompassing central bank asset purchases leading to bloated central bank balance sheets. But on the issue of impact of these policies on money growth, we find money growth has been elevated in all countries roughly in the same order as stimulus and inflation has fared across countries. And while money growth has surged beyond levels that any monetary economist would find consistent with a long-run low and stable inflation rate, money growth is also coming down and falling rather rapidly and consistently everywhere (across reserve currency countries). However, it is still excessive.

With the ECB having just shifted its inflation target to focus on an average of 2% inflation, this month’s 2% print for the year-on-year HICP is no longer a warning sign. But what we do not know is how much that desire for an inflation average at 2% going to dig back into the past or how much of it will look forward to what is coming next… The thing about undefined and unspecified averages is that they are harder to nail to the wall than Jell-O™. In the U.S., inflation is flaring and accelerating. But in the EMU, the numbers for June have turned up pretty soft for the largest EMU members. The headline gain in June is 0.4% which is a 4.9% annual rate when compounded. But among the four largest EMU economics, only Spain prints that result with the three largest EMU economics showing headline gains in the HICP in June of 0.1%.

Over three months, EMU inflation is an over the toppish 2.5% (annualized). But for the largest EMU economies, only Spain logs a very high pace at 5.4% with France at a more tolerable (given the new target mandate to hit an average) as its inflation pace is at 2.2%. Italy at 1.9% comes in under the 2% mark and Germany shows three-month inflation at 0.7%. The three-month inflation rate- which has no official standing- shows a break lower everywhere except for Spain. Still, there is broadly in EMU an inflation acceleration over six months compared to 12-months and over 12 months compared to the 12-month pace of one year-ago. Does the three-month slowdown obviate that?

Central bankers emphasize the 12-month inflation pace which is at a 2% for the EMU; Spain’s 2.5% shows excess pressure, Germany at 2.1% is fine, France at 1.9% is under the 2% threshold as is Italy that posts a weak 1.4% gain over 12 months.

There are a lot of gains here and there is a lot of acceleration, but there is also deceleration over three months as well as a move to lower levels by Brent crude prices and a slowing of money growth. We know that reopening the economy is one factor behind prices rising as are supply chain bottlenecks. But having said that, can we simply assume that those impacts will go away without legacy issues?

One thing that is interesting is the difference among the inflation rates in the U.S., the EMU, and Japan. All are seeing some pick up, but Japan’s bump up is merely a blip and still has not lifted year-on-year inflation into positive territory. EMU inflation occupies the middle ground with the U.S. inflation, where stimulus has been the greatest, showing the most pressure.

These observations lead us to the tentative conclusion that some of these pressures are global, and some of them are local and related to local polices. In the EMU, the unemployment rates were better maintained at a low level while in the U.S. unemployment skyrocketed and led to a larger infusion of fiscal support.

The small uptick in Japan’s inflation makes me think that the global aspects of the current inflation situation are relatively small. While the surge of inflation in the U.S. make me think that local polices are relatively more important.

EMU policy seems to be taking it to a smoother equilibrium than the U.S. Germany and Italy report out core or ex-energy inflation that shows more moderate price gains. Year-on-year German ex-energy inflation is at 1.7% over 12 months and for Italy core inflation is at 0.3%. Strip out energy and European inflation in these two countries remains quite well behaved. That is not true in the U.S. where even core CPI inflation is rising strongly.

I am encouraged that European inflation looks like the normal sort of thing expected when oil prices surge. And I’m further encouraged that oil prices seem to be slowing although there are still forecasts projecting oil to get back to $100/barrel. Whatever global inflation forces are brewing, they have not yet lifted Japan out of its domestic deflationary price funk. But in the U.S., its inflation problems seem to be peculiar to it, to the structure of its economy and to its policy responses as well as to its ongoing policy responses. Inflation globally is going to take a lot of close watching and this monitoring should be country by country or region by region where that is appropriate. There is a lot of change afoot because of the jolt all countries received from the virus. The adjustment to these changes will be ongoing and will continue to be affected by developments surrounding the spread of the virus and any issues with vaccines that arise. We should not allow our expectations to lean on dogma when looking to the future. There is too much in flux for that to work.

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