Economy in Brief: March 2022

Italy's inflation rate remains high and continues to show acceleration in February. The inflation gauge as measured by the HICP shows Italian prices up 1.3% in February, slightly less than the 1.5% they grew in January, but still a very high increase month-to-month. The HICP core gain was 0.9% in February, up from 0.5% in January. Italy’s domestic inflation measures continue to show heat as well.

Inflation accelerates broadly The sequential inflation rates for Italy show the headline rate going from a 6.1% pace over 12 months to a 9.5% annual rate over six months to a 13.8% annual rate over three months. For the core rate, that progression is 1.8% over 12 months, 4.1% over six months and 6.3% over three months. Both headline and core measures of inflation show acceleration. Prices remain hot monthly across the board. Not only is Italian inflation high and accelerating but the diffusion characteristics of inflation reinforce the notion that inflation is accelerating and broad. The diffusion index for three-month inflation is at 75%, for six-months it's at 75% and for 12 months it's at 58.3%. A diffusion reading at 50% implies that inflation acceleration and deceleration for the period are balanced across various CPI line-items. At 75%, the diffusion index is showing inflation is greatly tilted toward acceleration and we see that condition over three months and six months as well as a sizable tilt toward more inflation acceleration over 12 months.

Monthly trends Looking at monthly data the inflation rate across the various domestic components, we find it increased in all but two of them in February- that's an acceleration in all but two out of 12 components. Similarly, inflation increased month-to-month in January for all components except 2 and the same was true in December. The monthly data reinforce what we see in the sequential data: they show that inflation is accelerating period-to-period whether it's 12-months to six-months to three-months or December to January to February.

Quarter-to-date On a quarter-to-date basis- this is with two months of data in for the first quarter- inflation is rising at a 13.6% annual rate for the headline HICP and at a 5.4% annual rate for the core. The domestic measure shows headline inflation at an 11.5% pace with the core at a 3% pace. The domestic measures are slightly less hot than the HICP measures employed by the ECB.

Despite the high inflation levels in Italy, Italian inflation has generally been tracking below German inflation in recent years. Italy went through a period of austerity and was able to gain control of its inflation rate. But now inflation seems to permeate the economy and Italy has a clear inflation fight on its hands. Increases in global energy costs are going to continue to weigh on Italy, a country that is dependent on imported energy. The ECB will be raising interest rates to try to fight off these inflation effects as the year goes on, but inflation in Italy appears to be high, entrenched, and broad so the economy is going to have a lot of work ahead of it to put this inflation back down inside parameters that are acceptable from an EMU-wide targeting standpoint of around 2%.

The ZEW economic index for Germany fell more sharply in March than it ever had previously in its history. The German macroeconomic expectations index for March logged a -39.3 value after posting 54.3 in February; that change produces a net decline in the index of 93.6 points for the month. The U.S. expectations index also weakened, from 13.1 in February to -26.1 in March, a lesser but serious step-back.

Germany is reeling under the sanctions that it imposed on Russia in combination with the war in Ukraine on its doorstep. These two events have shattered expectations and caused current conditions to weaken sharply. In Germany, the current conditions index which was -8.1 in February has backtracked to -21.4 in March; this compares to a U.S. current conditions index that was 46.2 in February and has backtracked to 31.7 in March. Clearly concerns about the war and conditions in Europe have hit the German economy much harder than the U.S. economy.

At the same time, inflation expectations have moved sharply higher in March. For the euro area, the reading was -35.1 in February, rising to 69.5 in March. The German index in February was at -37.5; that's moved sharply higher to plus 70.2 in March. In the U.S., the index moved from -36.2 in February to plus 50.6 in March. The war came and the sanctions have been imposed and these are turning the entire economic picture inside out and upside down. The ZEW index shows a combination of dramatic and benign changes.

Markets continue to trade- did they simply discount everything? We usually expect markets to be the litmus test of economic events. But strangely the impact on markets according to the ZEW experts has been muted - in the survey at least. Euro area short-term interest rate expectations were at 50.3 for February and they have eroded only slightly to 47.2 in March. For the U.S., short-term rate expectations of 88.7 in February have become 86.7 in March.

The impact on long-term rates sees the German index going from 74.2 in February to 76.5 in March whereas the U.S. index moves from 78.0 in February to 81.5 in March.

Stock market survey shows reduced expectations but not dramatically so. In the euro area the stock market expectation index moves from a survey value of 32.9 in February to 22.1 in March; in Germany it drops from 34.8 in February to 21.4 in March; in the U.S. it barely budges moving from 28.5 in February to 27.3 in March. Of course, the stock market standings all are weak.

Summary Table: Stronger vs. Weaker The summary table show the economic situation weakening in the euro area, Germany, and the U.S. in March. Economic expectations weaken in Germany and the U.S. in March. Inflation expectations rise across the board for the euro area, Germany, and the U.S. Short-term rate expectations are slightly weaker in the euro area and the U.S. while long rate expectations are slightly stronger. For stocks, assessments are slightly weaker but not very dramatically. The survey shows dramatic shifts in economic variables and slight wiggles in market gauges.

The Bank of France business indicator rose to 107.1 in February from 106.6 in January. The index stands above its 12-month average which is at 104.4 and resides above its long-term average since August 1990 by a considerable amount. The indicator has a percentile standing on that timeline at its 82.6 percentile, a relatively strong standing for this indicator. Compared to just before the COVID emergency struck, the survey indicator is up by 10.4 points indicating a reasonably robust rebound during this two-year period.

Survey standings The components of the survey are a somewhat mixed lot. The strongest parts of the survey are for employment, both employment as expected and the employment change versus last month. Both of those line items have standings in their 90th percentile, in fact, in the upper part of their 90th percentile deciles. These are the indicators that are most responsible for giving the headline such strong standing. Apart from that, the order book standing is also relatively firm, at 89.2 percentile with the standing for foreign orders at 69.9% and for the change in total new orders at 72.8%. All of these indicators are somewhere between firm-to-strong. On the weaker side are inventories that have only 59.1% standing; still above their historic median although inventories are the only variable showing a net lower standing currently than they had in February 2020 before the virus struck. Capacity usage is also weak – indicating that a lot of slack remains in the system.

Trouble in paradise? Somewhat troubling is the response ranking for expected production. Expected production has only a 24.8 percentile standing, and it only increased by 5.6 points compared to February 2020. At a 24.8 percentile standing, expected production is well below its historic median indicating some trouble with the outlook on the part of producers. However, that standing flies in the face of such a strong standing for expected employment. So, there are things in this survey that raise eyebrows and may raise some concerns. However, for the moment, the survey doesn't seem to have any consistencies in it that cause us to think that it is seriously deteriorating.

Month-to-month and recent trends Turning to the month-to-month changes, the output change variable fell to 14.1 in February from 24.6 in January and that's also a decline from its December level. Expected production has been struggling ever since COVID struck.

Overall, there are nine components and the headline. Of the nine components, six weakened in February. Six have weakened on balance over three months and five have weakened over six months.

While output change has a solid historic standing, it has in fact struggled showing declines in four of the last six months and a net decline on balance. Expected production has weakened in February and is weaker on balance over three months but is stronger over six months.

Despite weakening in February, order books show declines in only two of six months and mark solid-to-strong increases over both three-months and six-months. Changes in orders are weaker than the volume of orders on the books as both foreign order and total order changes are weaker in three of the last six months and both series are weaker on balance over three months and six months on balance.

The change in finished inventories logs a negative value in February, but it improves from November. The series chronically logs negative values. Its current reading is a touch better than its 12-month average and above its historic median. Capacity use has weakened in four of the last six months and is lower on balance over three months and six months.

Both employment gauges weakened in February from their January level. Both have very strong high 90th percentile standings. The change in employment month-to-month was positive for four months in a row before declining in February. However, expected employment is lower in two of the last three months.

Outlook and risks On balance, the French survey looks sturdy enough. As often is the case with these surveys, the jobs components stay the strongest the longest. But there is some encroaching weakness for output and more outright weakness for expected production. There is still some lingering risk of an unknown dimension for COVID to return. Related to that, there are global supply chain problems. But the new risk is the War in Ukraine. Inflation is high and stubborn in Europe and higher and more stubborn in the U.S. The war is feeding inflation by pumping up oil and commodity prices. Central banks have work to do and yet the solidity of the economy is not assured and central banks for the most part have not even ‘begun to fight.’ What will happen when they do?