Economy in Brief

Europe is not just being roasted by global warming, extremely hot temperatures, and raging forest fires, but also by an extremely overheated inflation rate. The targeted HICP inflation rate for June rose by 0.7%, taking the year-over-year rate up to 8.6%. The core rate slowed in June, rising by 0.1%, after a gain of 0.5% in May, but it's up at a 3.7% annual rate year-over-year in June.

The headline inflation rate shows some cooling in its path as its 8.6% 12-month rate is at a 10.9% annualized rate over six months, then cools to a 6.5% pace over three months. The core rate, however, continues to accelerate from 3.7% over 12 months to 4.2% over six months, to 4.3% over three months.

The ECB at long last is getting ready to raise rates at this week's meeting. There is some speculation that there could even be a 50-basis point rate hike, not just a first-step 25-basis point rate hike. The Bank of Canada just hiked rates by 100bp; last meeting the Fed stepped its pace up to 75bp when 50bp had been expected. The ECB has been struggling with the issue of fragmentation which it's an attempt to deal with the disparate impact of inflation and rising interest rates across various European Monetary Union members. All eyes are going to be on the ECB this Thursday.

Clear, if mixed, inflation trends Inflation trends in the European Monetary Union are clear. Looking at the four largest EMU economies, the 12-month inflation rates range from a high of 10% in Spain to a low of 6.5% in France with Germany logging an 8.3% pace and Italy logging an 8.5% pace. The progression of inflation from 12-months to six-months to three-months over these countries shows mixed trends – but they are the same mixed trends across these four countries. There is acceleration from 12-months to six-months in all cases. Over six months inflation ranges from 11.9% in an annual rate in Italy and Spain to 9.5% annualized in France. However, over three months the inflation rate breaks lower in each of these countries, ranging between 9.7% in Italy to 5.3% in Germany. All these, of course, are clearly excessive rates and excessive compared to the 2% average that the ECB now aims at. Since the ECB is looking at some sort of (unspecified) average, it is likely that the higher 12-month inflation rates are more relevant for policy than the inflation rates calculated over short periods.

Core inflation trends Core inflation tells a slightly different story although it's not necessarily a story that is better; in some ways it is better and in other ways the story is worse. The story of core inflation is being told from lower levels of inflation than what we see in the headline. That much is good news. Over 12 months the inflation rate among the four largest EMU economies for either core or ex-energy inflation (ex-energy in the case of Germany) ranges from 3.5% in France to 5.4% in Spain. Over six months core inflation accelerates the same as with headline inflation. It accelerates in each country with the pace of inflation over six months annualized, ranging from 4.4% in Germany to 7.6% in Spain. But now we get to the part where things get worse rather than better. Over three months inflation accelerates in each of these countries. Inflation in Germany is the lowest at 4.7% while inflation in Italy is at a pace of 8.2%; inflation in France comes in at a 5.8% pace while Spain's rate is at a 7.8% pace.

Compares and contrast
Headline inflation in the EMU runs at 8.6% over 12 months and then decelerates to 6.5% over three months. The core inflation rate runs at 3.7% over 12 months but accelerates to 4.3% over three months. The levels of core inflation are more tolerable than for the headline, but the pattern for the core showing ongoing acceleration is more worrisome. These two measures leave the ECB with nowhere to hide.

A longer view
Also worrisome are the five-year results for inflation. The compounded five-year inflation rate as of June for the headline is 2.8%. Despite some persistent inflation undershooting before inflation jumped up, inflation has now become so strong in the recent months that the compounded inflation rate over five years has moved above a 2% pace. Core inflation, however, still fits inside of the objective of the ECB at a 1.6% pace. Looked at in terms of the four largest EMU members, each of them has a five-year average well above 2%. For Spain, the average is 3%; for Germany it's 2.9%; for France it's 2.5%; and for Italy it's 2.3%. However, the inflation rate for the core is still tame: German inflation excluding energy is up at a compound pace of 2.1% arguably at the borderline of acceptability. Spain logs a 1.7% pace, France logs a 1.6% pace, while Italy's pace for compounded inflation is 1.3%.

Excess inflation
Excess inflation is still largely being driven by energy as well as food components. When we exclude those two things and look at core inflation, it is better behaved; however, it is still over the line. Over these longer five-year periods, core inflation appears more suitable. But for how long with that be the case with inflation still running so hot?

ECB policy challenges
The ECB continues to have problems and questions with the outlook for energy in July still in flux. Brent energy prices measured in euros fell by 3.8% in June after rising 23% in May and 9.6% in April. Brent measured the same way rose at a 184% annual rate over the last three months. And there are ongoing concerns about what will happen with energy prices. U.S. President Joe Biden just got back from a trip to Saudi Arabia where he tried to convince the Saudis to pump more oil to help alleviate the stress on world markets. In the immediate aftermath of this trip, it doesn't sound like he was very successful, but time will tell what OPEC-plus will do.

Japan's surveys - for those available through June- show mixed and inconsistent readings. This suggests that the economy is going through some turmoil since indicators for the same economic concept are sometimes giving very different readings.

We saw that already with release of the industrial production report that showed abject weakness in contradiction to the S&P Global manufacturing PMI readings that are showing continued expansion in the sector.

Japan's economy watchers indexes are quite high-valued with standings in the 90th queue percentile except for the retail sector. However, even for the economy watchers framework, the future index is substantially weaker with only a 39th percentile standing.

All Teikoku indexes are below the 50th percentile which puts them below their median readings. However, most of them have readings that are in the 35th percentile to 40th percentile range with wholesaling being an exception and closer to its median value of 50%. The main readings from the METI indexes show the reading for industry has a 3.5 percentile rank standing which makes its signal much more like what we see from industrial production. The reading for services has a 47.9 percentile standing which agrees with the Teikoku framework and it's much weaker than the economy watchers indexes.

However, in the table we also evaluate these same indexes by looking at their ranking in terms of growth year-on-year. In terms of growth the economy watchers indexes are generally weaker but are still quite firm with the overall economy watchers index at a 75-percentile standing instead of the 90% standing it has on its level. The future index evaluated in terms of yearly changes falls from a 39-percentile standing to a 26-percentile standing – it becomes even weaker. The Teikoku indexes looked at it in terms of their changes have growth rates that are generally higher than their level standings; manufacturing for example has a 44-percentile standing (42% on levels), retailing has a 58-percentile standing (39% on levels), services have a 78-percentile standing (40.6% on levels) and so on.

The growth ranking from the METI indexes gives stronger readings than the level indexes with the industry ranking rising to 15th percentile from the 3.5 percentile, a stronger reading but still a very weak reading – and not much change in economic terms. However, for the tertiary (or services) sector the 48-percentile standing for the index level moves up to a 96-percentile ranking in terms of growth.

There also are readings for the leading economic index. The LEI when evaluated as an index level has a 78-percentile standing; however, evaluating the growth of the LEI index finds that standing falls to the 42nd percentile below its historic median.

The rankings of these metrics on growth or levels shows idiosyncratic differences. The economy watchers complex gets a little weaker, Teikoku get stronger, the METI readings are mixed, the LEI is weaker when evaluated on growth. There is little generalization here.