Economy in Brief: February 2022

Table ZEW Qualitative Assessment identifies the main trends of the month; colors help to discern general magnitudes of importance. The economic situation is shown to be stronger for the EMU, Germany and the United States in February, compared to January levels. However, Germany has a level of improvement that still leaves it below its historic median (below a rank standing of 50- hence the red color).

Economic expectations are stronger for Germany and weaker for the U.S. where the Federal Reserve is making noises about being much more aggressive than the European Central Bank. However, the ECB has recently changed its tune from no new music in 2022 to perhaps a new note- but not a symphony like the Fed seems to be planning. So the ECB has abandoned its view that inflation - which is excessive- will slowly, organically, dissipate, and all will live happily ever after, while the ECB simply watches from a front row seat.

And expectations for inflation are higher across the board although they all come with values well below their historic medians. In fact, inflation expectations, while higher in each case, are higher by very small amounts that leave those expectations at very low historic standings. The sense of increase is there; as always, we wonder if it is a turning point or just a point of inflection.

Part of the reason for still low inflation expectations is the expected path of short-term rates, a euphemism for what central banks are expected to do. Short-rate expectations are stronger; in fact, are at a very high standing for both the U.S. and the EMU. Yet, long-term rate expectations are split- higher for German and weaker for the U.S. Still, that response is deceptive since both the U.S. and Germany have extremely high standings for their long rate expectations. The mixed changes on the month don’t seem to tell the real story. Part of that story is real since the level of rates in Europe generally is so low that ZEW experts may be espousing the view that even if the Fed hikes rates faster -and faster than in Europe- the impact on U.S. long rates will not be very pronounced.

One thing that the Fed worries about is that if it hikes the Fed funds rate significantly the impact on U.S. long-term rates will be muted. Since U.S. rates are already higher than in Europe, further increases may spur capital flows into dollars to invest in rising U.S. long-term rates and that could cap the Fed’s ability to bring pressure on long rates reducing the efficacy of monetary policy. It certainly complicates the outlook, but that has always been the case. Long-term capital markets are connected, and such pressures are part of what domestic monetary policy must learn to live with. The ZEW experts seem to acknowledge it.

Stock markets have been strong and have been the beneficiaries of interest rates so low that many investors have sought refuge in stocks as the only place to earn a real return on investment. Stock expectations by ZEW experts are mixed with the U.S. and Germany stronger and a weaker response for all of the EMU while Germany and the EMU lag below their historic medians. The U.S. itself is on the edge and barely above its own median.

Different strokes for different folks The ECB has been under growing pressure and criticism for its lackadaisical approach to inflation. As the year began, Christine Lagarde assured everyone that policy was in control and that there was no reason for a change in policy in the year ahead. But then as the month of February began, a different view was expressed opening the door for a policy move. The new view is that “Inflation is likely to remain elevated for longer than previously expected but to decline in the course of this year” (Christine Lagarde, here). So, the ECB views risks as more tilted to the upside. The days of stonewalling the excesses of inflation in the EMU are gone. But it is not clear how much policy action will now be employed to face what is a substantial overshoot in the monetary union that is ongoing with more risk than previously believed. The ECB is no longer saying a policy rate increase this year is very unlikely. So much for what in the U.S. they call ‘forward guidance.’

The Fed burned that bridge a while ago although it is far too soon to say that the ECB is now going to walk the same walk as the Fed. It certainly is not talking the same talk. But now the policy-change door is open.

The ECB had previously focused on how inflation would run-off and how some of the very factors causing inflation to rise would eventually cause to slow. Now that view seems to apply only to the letting off some steam and not able to achieve a full-blown return to target by itself.

Still, in Germany, the largest economy in the EMU, the January HICP and core rate both had made a clear turn to a lower rate of expansion (both still quite excessive relative to the EMU-wide target rate, of course).

Finland sent 2021 out in style as its 3.1% gain in industrial output in December demonstrates. The gain is part of a series of indicators that now stretches back for six months. Output in Finland is gaining at a 17.3% annual rate over three months, part of an ongoing acceleration from 12-months to six-months to three-months. Utilities and manufacturing also follow this patten of sequential acceleration.

Mining and quarrying output is super-heated but not accelerating since its pace of 84.5% over six months is well ahead of its extremely strong pace of 44.2% over three months. Food production slowed over six months but growth in food output over three months is much stronger than over 12 months. And textile output has simply been gaining pace steadily from 12-months to six-months to three-months.

In December, all sectors and industries showed not just solid but strong gains. By comparison, November and October were a bit more uneven in their span of results.

Inflation has run hot in Finland as it has elsewhere in the EMU. Headline HICP inflation has asserted itself, rising from a 3.2% pace over 12 months and six months to 5.0% over three months. Core inflation has ridden up from 1.9% over 12 months to 2% over six months to 3.1% over three months. Compared to the EMU, Finland's trends are muted. Moreover, in December despite the heat in output from industrial production, inflation has cooled in with the headline dropping by 0.2% month-to-month and the core rising by just 0.1%. Finland's results are what the ECB and the Federal Reserve want desperately to see in their macro data. But the U.S. data for January show inflation acceleration. Finland is a special case.

Growth in the just-completed fourth quarter was strong at 11.2% for overall IP; all sectors were strong except for food where production slipped at a 0.8% annualized rate in the fourth quarter.

The chart at the top of this report shows the level of IP in Finland and how it has performed. The table calculates January 2020 to date data on performance. The ratios in the table show that IP has gained sharply since just before Covid struck (except for mining and quarrying). And the chart affirms the strength in the output rebound. Finland looks to have completely recovered (even relative to trend!) from the Covid smackdown. However, output is still undershooting relative to its previous trend because Finland was hard hit in 2019 when there was a global trade slowdown in the wake of the Trump tariffs on China. Finland still is not back from that set-back. But it is doing well, and it seems to have put the economic impact of Covid behind it despite ongoing infections.