Inflation is not rising sharply in the euro area. The nature of this inequality is not the same as in the United States. Even if the level of inflation even lower than observed in America, the situation looks much more worrying and the solutions are less clear. At the same time, the ECB still far outperforms the prospects for monetary normalization.
Inflation galloping in Europe as in the United States
According to the recently released consumer price index, theUS inflation has risen to 8.6% for the past year. This is the highest level since forty years.
At first glance, European countries seem to be going through the same inflation problem: 8.3% in Spain, 7.4% in Germany, 6.9% in Italy or 5.8% in France. More generally, at euro area level, year on year, inflation reached 7.4% in April and 8.1% in May. This is the highest rate of inflation since the creation of the monetary union.
Different inflation dynamics
One might think that both phenomena are analogous. In fact, these figures include two very different dynamics between the two continents. On the one hand, US inflation appears to be generalized and, above all, linked to national phenomena. We are seeing significant price increases for traditionally less volatile components, such as housing. In fact, the monthly growth in the house price index in America is the highest since 1990.
Conversely, in Europe, inflation is mainly concentrated in volatile sectors are often at risk of runways. In the first place, energy and food, which have suffered from the severe supply disruption observed in recent months. In fact, it is the core CPI, which excludes these two categories from inflation calculation three percentage points lower in Europe than in the United States. Rising energy costs contributed to approx 2% of overall annual inflation in the United States. In the euro area, this figure is 4%.
These comparisons clearly show that there is a fundamental difference between the eurozone inflation problem and the American problem.
The level of American demand is now higher than its pre-COVID level, a that is not the case in the euro area. It should be remembered that the growth of Europe especially anemic before the crisis of health and consequent unemployment. As for (official) inflation, it has been for more than a decade below the ECB’s 2% target. Some economists even thought that deflation was the real threat and that globalization had killed inflation.
As if printing hundreds of billions amid under-investment in energy infrastructure and peak oil will sooner or later affect the value of the currency …
In Europe, so it is clear that inflation is not a problem of excessive demandit’s instead of supply problem. The Old Department has been experiencing unprecedented turmoil in recent months in the field of energy. Russia did not invade Ukraine to increase the natural gas shortage.
Final consumer prices have not been fully advanced. We can therefore legitimately assume that the evolution of the price of energy will remain a crucial factor in the dynamics of inflation.
Wages stagnating in Europe
The euro area is in a much more difficult position than in the United States: high inflation and moribund growth. In the USA, revenues are rising and actual output growth is rapid and is accompanied by inflation. Conversely, in Europe, wage and income growth is weaker and inflation just as high. In Europe, inflation is high imports and influences prices, but not wages. US inflation is like that less painful than European inflation.
When we take a step back, we can analyze this development as the flip side of the economic choices made during the pandemic. Rapid implementation of European states of interest programs to maintain the level of employment and guarantee income (the “whatever it takes”).
On the contrary, the United States could not afford to implement such massive measures so quickly. That led to the flexibility of the American labor market huge layoffs. It was only later that the US government decided to inject billions of dollars as an incentive stimulating demand and boosting employment.
The gas problem
European natural gas prices have started to rise mid 2021when the Russian exports began to decline and European gas stocks declined. Since then, prices have only risen, although Europeans can hardly change their behavior, because much of home heating is provided by natural gas.
In 2019, Russia was almost equal 50% of German natural gas imports. The war in Ukraine is therefore an essential element in understanding the problems of energy supply. Even if Ukraine is falling, the confrontation with Putin is likely to last. Tsar Putin referred to Peter the Greata couple of days ago.
So the only real alternative for Europe is to go to the United States for its liquefied natural gas (LNG). It’s over allied country only able to protect Europe from an even greater energy shortage.
American gas: the salvation of Europe?
Total US exports to Europe are currently approx 20% of total EU consumption. However, such a change would take a long time as the United States currently does full liquefaction capacity. Admit it, the demand for LNG is from Asia collapse after COVID lock – in in China and Hong Kongbut the claim could return if China change health strategy.
August 2023’s European natural gas futures are just trade 10% by the future of 2022. This thus indicates that the high level of gas prices should remain in 2023. German think tank Dezernat Zukunft estimates that German households will lose on average. 221 to 442 euros for increased electricity and natural gas costs in 2022 and 472 to 897 euros in 2023.
One of the decisions that could be taken to alleviate inflation is for Germany to follow the example of Belgium and extend the life of its latest nuclear reactors. Otherwise, the country will have to resort to electricity production from coal.
Or maybe when the feeling is over, the German leaders (who were already reluctant to deliver weapons to the Ukrainians) will reconnect with the Russian service station as they have been doing it since 2014 ?
The ECB is slowly changing its strategy
25 points to eradicate inflation
Although the Eurozone has a different inflation problem to the United States, it is still pursuing the same strategy. After feeding, The ECB recently announced its intention to raise rates for the first time since 2011. At this stage, the Governing Council has announced its intention to increase its principal interest rates by 25 basis points at its July meeting. The ECB should in theory retiring from the negative rate path by the end of September. As a reminder, the interest rate on deposits is at -0.50% (historical lowest level).
Going towards the recession?
The ECB estimates that annual inflation should reach 6.8% in 2022, rising to 3.5% in 2023 and 2.1% in 2024. (Inflation forecasts are not even worthwhile and economists are always wrong). The ECB does not seem to learn from the American example, which took too long before it acted on the admission of its leaders. If inflation expectations fall, rate hikes will have to be even bigger. And 25 points is certainly not enough.
At the same time, the Central Bank conducted a review a 1% reduction in its 2022 GDP growth forecast. This would be close to 2.8% in 2022, 2.1% in 2023 and 2.1% in 2024. Just like the Federal Reserve, aware of the mismatch of inflation, the ECB seems to be opting for a recession over inflation.
More difficult funding conditions
The IS expand between the links of southern European countries such as Italy or Greece and the rapidly increasing Bund, which shows deteriorating financial conditions and a more difficult lending environment for national governments. This is also true for companies that are subject to more stringent financial conditions than in the United States.
Even if Christine Lagarde seems to have changed her discourse on monetary policy, that is the case the ECB is certainly not able to make the most of the forecasts. The latter has the potential to raise its rates rapidly without causing massive damage to the economy thanks to the hegemonic position of the dollar.
The economic performance of the euro area since the late 2000s is unfortunate. The continent has suffered from more than a decade of very poor growth. The current inflationary crisis is another difficult challenge for continental economic policymakers.
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