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Economy in Brief

EMU GDP Growth Still Runs Hot As Quarterly Pace Slows and Inflation Cooks
by Robert Brusca  October 29, 2021

The quarterly gain for EMU GDP was 9.1% in Q3 after rising at an annual rate of 8.7% in Q2. However, the Q3 pace on a year-over-year format shows growth of just 3.7% and it slows sharply from its Q2 pace of 14.2%. In fact, year-on-year growth slows for all the countries in the table and for all of them the showing is sharp on year-over-year basis. On the other hand, growth quarter-to-quarter is stronger and more mixed. Of the six early reporting EMU countries, three show GDP slow in the Q/Q framework. The growth rate for the largest four economies speeds up in Q3 while the growth rate of GDP in the rest of EMU slows down in Q3. Trends are mixed. As a reference the U.S. reports growth slower quarter-to-quarter growth at 2.0% from 6.7% in Q2.

Still, the year-on-year growth rates are strong in most places. The EMU pace has a top 10 percentile standing on growth rates ranked back to 1997 (at 92.4%). Belgium, France, Italy, and Portugal also log top ten percentile growth rates on year-over-year growth. The U.S., too, is a member of that club. Not in the club are Germany with growth at just its 72.8 percentile and Spain with its growth below its median at a 47.8 percentile standing.

When we look at the ranking of growth in the four largest economies, as a whole it has an 84.8 percentile standing. I do not calculate a standing for the rest of the EMU since membership has changed historically.

In a separate report, the early inflation reading for EMU logged a gain of 4.1% in October (preliminary), up from a 3.5% pace in September. Year-on-year inflation in Germany hit 4.6%. It hit 5.5% in Spain, 3.2% in France, and 3.1% in Italy. It is now running above the EMU-wide 'point-target' of 2% in each of the big four EMU economies. And the inflation rate accelerated month-to-month based on its year-on-year pace.

Sequential growth rates (12 months to six-months to three-month) show inflation accelerating in the EMU, France, Italy, and Spain. The lone exception is Germany where inflation ran at 4.6% over 12 months settled to 3.9% over six months then spiked to a 5.2% pace over three months. Apart from sequential acceleration, inflation over three months is higher than it is over 12 months in all of the big four economies.

Central bankers continue to toe the line of belief that inflation is transitory. Of course, only history will 'prove' who is right on this debate. But right now, central bankers are losing as inflation is high and rising in the EMU; in the U.S. inflation is high and a new wage report shows acceleration- potentially paving the way for a price-wage/or wage-price spiral.

Of course, to some extent there are inflation favorable base effects at work as the '12-month year-ago' column shows with EMU inflation falling at a 0.3% annual rate one year ago and negative rates of change for prices in each of the big four economies except for France.

One year-ago the low inflation rate was 1.9 percentage points below what is now the five-year average. And currently the 12-month inflation rate is 2.5 percentage points higher than the five-year average. So, there is now slightly more excess inflation than there was excess disinflation one year ago. And each big four economy is showing more excess inflation now than it showed excess disinflation a year ago. This compares actual inflation rates to the running five-year average not to the ECB target.

Less growth and more inflation?

If we instead compare actual inflation rates now and a year ago to the target reference of 2%, we find mostly small differences between the overshoot now and the undershoot of a year ago. Currently inflation is 2.1 percentage points above the hypothetical target line while a year ago it was 2.3 percentage points below it. This symmetry is useful to keep in mind with the ECB now pursing average inflation targeting.

We are coming from a period of excess disinflation and so the excess inflation is a shock to the system. But the shock relative to the old target 'ceiling' isn't any greater than was a year-ago when the 'miss' was an undershoot. However, one clear difference is that under the old system undershoots were not a concern while any overshoot was considered a catastrophe. So, there is this problem of interpretation. What seems to be symmetry may not be that at all. To the inflation-hating nations in the EMU, this overshoot especially with interest rates so low is a clarion call to action that too-low inflation was not.

We have these calculations as a reference...

Even now with inflation flaring, inflation when averaged, seems like it is still 'on track' – pick your period for calculating your average… But inflation averaging is a continuous process- something policymakers should bear in mind. Today's inflation will be part of an averaging process used in the future. If a country or region is coming out of a period of disinflation, a period of excess inflation may seem normal and appropriate to balance the past. But making policy that way means that, in a few years, the average calculation will drop the low inflation period and all that will be left is the high inflation 'overshoot period' and its aftermath. That will boost average inflation in the future. That is why it is important to not let any overshoot send prices too high or last too long because any consistent targeting program will exact a toll for this behavior later on.

The inflation situation
It is still not clear how the inflation situation will play out. But there are distortions and not all of them will go away 100%. Global supply line problems damp international competition and raise prices. They also create product and input shortages that tend to boost prices, through the rationing function of prices. Firms will be moving their supply lines in the future to gain more control and stability, which is something that could affect competitiveness and pricing in the future. Moreover, prices, long capped, have now been freed to move and to rise. The simple discipline of that past price stability has been lost. And goof habits lost can be hard to reacquire. In addition, labor markets have gotten tighter as the pandemic has influenced some decisions to work or not as well as to retire early.

A lot has changed. We are not in the same low inflation environment that had prevailed prior to Covid. It's more than just some supply chain issues. In addition, the world faces added expenses as it seeks to act on greenhouse gases and to burn less fossil fuel. But some countries, like China, are finding the pledge that they made on coal and other things will be impossible to keep. When push comes to shove growth wins and green gets kicked to the gutter. Will that reality remain, or will it change? Changing it might be good for greenhouse gas reduction, but it will be bad for growth and for prices. It is not easy being green, nor is it cheap.

Commentaries are the opinions of the author and do not reflect the views of Haver Analytics.
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