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Economy in Brief

ZEW: Dire Expectations
by Robert Brusca  June 14, 2022

Economic expectations did improve slightly in June –for Germany they improved by more than they deteriorated in the United States - but they continue to cling to very low levels in the ZEW framework. The U.S. and Germany, according to ZEW experts, have economic expectations in the bottom 12 to 10 percentiles of their respective historic ranges. These are obviously very weak results.

The economic situation, the current situation, is assessed below its historic median (below a 50% standing) and while it is below median, the current situation is not particularly dismal. For the euro area the economic situation has a 46-percentile standing, for Germany it has a 38-percentile standing, and for the U.S. it has a 45-percentile standing. These standings generally improved slightly on the month, but they remain below normal (below their historic medians).

The bigger change on the month comes from inflation expectations. Inflation expectations deteriorated in terms of the diffusion averages for the euro area, Germany, and the U.S. by 22 points on average during the month. That is a sizeable average deterioration. The percentile average for these expectations puts it in its lower 8 percentile. That means that the negative readings for inflation have been worse than this month only about 8% of the time. The U.S. reading alone has been worse only 1.4% of the time.

Inflation has clearly jumped up and taken central banks by surprise- and based on the assessment revisions - it has taken the ZEW experts by surprise too. There are several reasons for this; the first being that over the previous 20 to 25 years inflation had been harnessed and controlled around the 2% sweet spot that central banks had sought. In fact, central bankers may have become a bit complacent thinking that inflation would control itself. In recent years, both the ECB and the Federal Reserve have gone out of their way to engage in policies to support growth without much regard for what would happen to inflation under the assumption that inflation would control itself. And for a long time, that worked. There was a highly competitive global environment with a great deal of international competition and the supply of low-cost goods flooding in from Asia, particularly from China kept prices down- but it did not last.

When COVID struck all of this changed. And what didn't change were the attitudes of central bankers. Fiscal and monetary policies were directed to cushion the blow from COVID as locked down or isolated consumers impacted economic growth adversely. But globally fiscal and monetary policy was set to work in unison to create stimulus and it seems that nobody took account of this. And at the same time, domestic policy makers seemed to all want to err on the side of being too generous. In the wake of COVID, supply-chain issues disrupted the flow of goods and disrupted the state of international competition. For a long while, services were hard to consume causing consumers to concentrate their purchases in goods which came in short supply and saw their prices ratchet up. Central bankers still in some sense 'didn't get it' and continued to make policies as though all the anti-inflation backstops were still in place even though they weren't.

There's a global story of an inflation foul up as well as very country-specific local stories that can be told about how central banks and fiscal policy messed up. But in the end, it all worked to create more inflation. And now it's here, it's unexpected and it's being exacerbated by Russia's invasion of Ukraine. That invasion adds to price pressures and is leaving food supply shortages and higher prices that threaten the developing world the most.

The ZEW experts, this month raised their expectations for short-term rates. The change in their expectation for short rates is not much, but the assessment of where short-term rates will be is a relatively high assessment. The expectation for longer term rates has come down in part because the expectation for short-term rates has gone up. For Germany, the long-term rate expectations are high whereas for the U.S. the expectations are still more moderate. However, the events of the past few days may affect what ZEW experts are thinking about the future the next time they are surveyed. Stock market expectations are weak everywhere although they were revised slightly higher on the month. Based on what we see happening in markets, that's unlikely to happen again next month.

Summing up
This is obviously a dynamic situation. The ZEW survey occurred before a lot of the deterioration in markets and before some of the recent inflation measures were announced. Even so in the financial experts' opinions, we can see change is afoot. Perhaps the next big change will be to see a downward revision in the economic situation as the experts begin to see the increases in interest rates and stubborn inflation having an impact on actual economic growth and not just expectations. But that's a speculative statement on my part and we will have to wait to see what the ZEW experts say next month.

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