Frankfurt-Eurozone inflation has exceeded the European Central Bank’s target in a temporary “hump,” the ECB said. It shattered the metaphor used by then-President Jean-Claude Trichet 10 years ago.
In 2011, the ECB raised interest rates twice every four months, and Trichet succumbed to German pressure, despite believing that commodity price increases were short-lived. This is also acknowledged by the ECB itself as a policy error that exacerbated the eurozone debt crisis.
Current ECB policymakers who have learned the difficult way say they will not tighten monetary policy until inflation stabilizes at the bank’s 2% target.
The ECB last week blamed the recent rise in prices for more expensive raw materials and supply bottlenecks due to pandemics: “Inflation outlook features a 2021 hump followed by milder interest rates in 2022 and 2023. “.
Inflation in the US on Tuesday in August was the slowest in six months, and could emphasize the idea that recent price pressures are temporary.
However, the ECB is on the lookout for signs that inflation spikes are turning into more durable ones, especially when consumers and businesses suffering from high prices adjust their expectations accordingly.
Here’s why ECB policy makers are sticking to the “hump” story and the indicators they are monitoring:
What is the hump made of?
Inflation in the euro area soared to 3% in August, the highest in 10 years. This increase was due to energy costs, but so did the prices of manufactured goods and food.
This is because the COVID-19 pandemic puts a strain on global logistics due to hygiene restrictions and labor shortages, freight rates hit record highs and imported goods became more expensive.
In addition, the price of some grains soared due to poor crops.
The chart of container fares is skyrocketing.
Will this disappear?
Central banks in 19 euro-using countries believe that price growth will slow as these supply-demand imbalances ease.
They believe the rise was partly explained by the “basic effect,” and prices fell abnormally a year ago as the pandemic closed businesses and kept people home. They also cite German VAT cuts that were part of the government’s COVID-19 support package.
Meanwhile, the high levels of structural unemployment and aging in the euro area serve as the upper bound for its long-term growth and inflation outlook.
The ECB expects inflation to average 2.2% this year before returning to 1.7% next year and 1.5% in 2023.
Core inflation, which excludes energy and food prices and appears to better show the underlying trends, is expected to hit 1.6% in August, with an average of 1.3% to 1.5% over the next two years.
For the ECB inflation forecast chart:
Is the Hawks on board?
Yes. Even Germany’s Isabel Schnabel, the most hawkish member of the ECB’s board, agrees that “probably inflation will drop significantly next year.”
This is far from 2011, when ECB Chief Economist Jürgenstark pushed for two rate hikes, equivalent to a total of 50 basis points, contrary to his own staff’s prediction that inflation would fall.
At the time, Stark emphasized the risks “related to further rises in energy and commodity prices,” but Trichet refused to put more emphasis on core inflation.
In contrast, ECB Governor Christine Lagarde emphasized the slump in core prices this week, saying “premature monetary tightening in response to a temporary rise in inflation will hinder recovery.”
Austria’s central bank governor Robert Holzmann is the most radical, arguing that price pressures could last longer than currently thought and the ECB could tighten policies faster than expected. It seems that you are looking at it.
For Eurozone Inflation Diagram: It Depends on Who You Ask:
What if they are wrong?
The ECB has a disastrous track record in forecasting inflation, underestimating price pressure between 2009 and 2011, and then overestimating price pressure over the last decade.
Its economic model, like any other model, estimates the future from the past. In short, we could predict that prices will continue to stagnate due to too low inflation over a decade.
That’s why central banks are keeping an eye out for signs that soaring prices can affect wages and consumer and corporate expectations, creating an inflationary spiral. Virtually anything that undermines the “hump” story.
The ECB chart has chronically overestimated inflation.
There is no definitive proof
So far, there is no conclusive evidence that this is happening.
On the one hand, German consumers expect inflation to reach 3.6% in the next 12 months. This is the highest level since the polls of the Deutsche Bundesbank began.
There are also widespread reports of staff shortages, especially in restaurants and bars.
Meanwhile, consumers were reluctant to use all the savings they had accumulated during the COVID-19 blockade, and wage growth was modest.
The German union’s first gambit to raise wages for local civil servants by 5% was less than the 6% required in the previous round of 2019, and the final German wage reward is usually far beyond the first claim. It is below.
Wages across the euro area rose 2.1% in the first quarter and then actually fell 0.4% in the second quarter, according to Eurostat data on Wednesday.
This uncertainty is why the ECB pushed up its decision on the future of stimuli in December.
“We will pay close attention to the usual fall negotiations in some countries,” Lagarde said last week. “But at this point, these wage increases … don’t seem very strong.”