Economy in Brief: 2022

Inflation in the European Monetary Union in July finalizes at 8.8% year-over-year. The gain for July is 0.7%, slightly softer than June's 0.8% and the same as May’s 0.7% rise, marking a strong run of price increases in the European Monetary Area.

Among the largest economies and the EMU, Spain's year-on-year inflation rate at 10.7% leads the parade, followed by Germany at 8.4%, Italy at 8.3%, and France at 6.8%. The United Kingdom, the second largest European economy but not a European Monetary Union member and no longer a European Union (EU) member, logs inflation at a 10.1% pace over 12 months. In all cases, the year-over-year inflation rate has accelerated at least slightly compared to the month before, and (of course), sharply form the year before.

While it seems inflation has been elevated for a long time, comparison with inflation rates a year ago remind us that that's an illusion. Twelve-months ago the pace in the European Monetary Union was excessive but stood at 2.4%. German inflation was excessive at 3.2%, Spanish inflation was excessive at 2.9%, but French inflation was within the target parameters at 1.5%, as was Italy's at 1.0%. Inflation in the euro area has been creeping up over the target for a while, but the aggressively excessive inflation is still a relatively new phenomenon.

Core vs. headline The results for core inflation underscore that core inflation rates are significantly below the headline. The overall European Monetary Union rate at 8.8% is more than double the pace of the core that is up by 4% year-over-year in July. Individual member rates are substantially below headline rates as well. Spain has the highest core rate at 6.2% (but that is still only about 60% of the headline pace in Spain). Spain’s strong core pace is followed by Germany’s, whose ex-energy rate is 4.4%, then by France where the core is up 4.3%, and in Italy with the core up by 4.2%. In comparison, the U.K. has a much hotter core inflation rate running at a 6.6% pace.

Acceleration The tendencies for inflation to accelerate breakdown a little bit this month. For headline inflation six-month inflation accelerates compared to 12-month inflation but then the three-month inflation rate steps down to a 9% pace from a 10.1% pace. Core inflation at 4% year-over-year dips to a 3.7% pace over six months and then jumps back to a 4.5% pace over three months accelerating vs. both its six-month pace and its 12-monht pace.

Acceleration by country Headline inflation among European Monetary Union members shows all members with accelerating inflation from 12-months to six-months. However, from six-months to three-months inflation accelerates in Italy and in Spain while it decelerates in Germany and in France. However, only in Germany among EMU members is the three-month pace of inflation below the 12-month pace of inflation.

Core inflation among EMU members shows acceleration everywhere from 12-months to six-months. From six-months to three-months, however, ex-energy inflation decelerates in Germany, while core inflation accelerates and all the other EMU members. Also, German core inflation is lower over three months than over 12 months but for all the other EMU members three-month inflation exceeds 12-month inflation.

Energy prices Oil and energy prices have been a clear driver of inflation in the European Monetary Union with Brent prices expressed in euros up by 64.1% over 12 months, up at an 85.9% annual rate over six months and now slowing as they are up at the 21.6% annual rate over three months. The monthly data shows sizable Brent price increases in May and June but in July prices broke falling by 7.3% month-to-month.

Japan's trade deficit widened in July rising to ¥2.1 trillion from ¥1.95 trillion in June. Goods exports rose by 2.1% in July; goods imports rose by 3.5%. Imports continue to outpace exports over various horizons from 12-months and over shorter periods.

Growth rates show imports at an increase of 51% over 12 months, rising at a 59.9% annual rate over six months and at a 66.2% annual rate over three months. By comparison, exports are up at a 21.2% annual rate over 12 months, a 28% annual rate over six months and at a 40.4% annual rate over three months.

Imports are rising strongly on the back of rising energy prices but also on the back of a weakening yen that increases the import bill. Of course, that increase also includes energy prices because not only are the dollar prices for energy high but when translated into yen at the weaker yen exchange rate the cost of energy rises again.

Ironically, exports are doing better; the export growth rate is 21% over six months moving up to a 40% annual rate over three months. The weaker yen will provide a great opportunity to increase Japanese exports in nominal terms. When the yen weakens, against the dollar, it causes the dollar price of Japanese exports to fall and that should increase exports. At the same time, Japanese exporters can take some of that decline of the yen into a price increase and actually raise their yen prices while lowering their dollar prices and getting a double kick in export value. This, in fact, might be starting to happen but because import prices are so strong you still don't see it in the trade balance.

This is not unusual because of something known as the J-curve phenomenon. The J-curve phenomenon refers to the fact that when a currency changes its value the price effects go through first while the volume effects occur later. In this case when the yen gets weaker, import prices in Japan will go up quickly. In time, Japanese consumers may decide that goods are more expensive, and they may buy fewer of them. That will cause import volumes to recede blunting the impact on import value from the price rise. On the export side, the weaker yen should encourage foreigners to purchase more Japanese products, but that volume effect takes some time and in the meantime there is a bigger increase in import value than in export value that widens the trade deficit which gets worse before it gets better.

The table shows that over 12 months the yen is averaging ¥119.6 against the dollar, whereas over three months it's at ¥133.2. In July it has slipped further to ¥136.7. Over 12 months – point-to-point – the yen has fallen by 24% against the dollar whereas over three months it's falling at a 37% annual rate, a slightly faster pace. The broad yen index that figures the yen value against Japan's most important trade partners, broadly shows the yen is weaker over 12 months, at a -16.9% annual rate. Over three months it's falling at about the same pace, at a -17% annual rate.

The price data showed that export prices are rising by 19% over 12 months and at a 20% pace over three months. Import prices are up 47.9% over 12 months and at a 57.6% annual rate over three months. Import prices are really killing Japanese imports and the trade balance.