Frankfurt—The increase in euro area inflation from the European Central Bank’s target is a temporary “hump”, the ECB says—to dust off a metaphor used by its then-president Jean-Claude Trichet a decade ago.
In 2011, the ECB raised interest rates twice in four months, despite German pressure from Trichet believing that a commodity-fuelled rise in prices would prove short-lived. This has now also been acknowledged by the ECB as a policy mistake that has exacerbated the euro area’s debt crisis.
After learning the hard way, current ECB policymakers say they will not tighten monetary policy until inflation stabilizes at the bank’s 2 per cent target, which they expect to last for more than two years. Not there.
“The inflation outlook is characterized by a hump in 2021 followed by more moderate rates in 2022 and 2023,” the ECB said last week, blaming recent price increases on more expensive raw materials and supply constraints arising from the pandemic.
Tuesday’s August US inflation readings, the slowest in six months, could bolster the idea that recent price pressures are temporary.
But the ECB will be on the lookout for any signs that inflation growth is becoming somewhat more sustainable, especially if consumers and companies are plagued by higher prices, to adjust their expectations accordingly.
This is why ECB policymakers are sticking to the “hump” narrative and what indicators are they monitoring:
What is the hump made of?
Euro area inflation hit a 10-year high of 3 percent in August. The cost of energy increased, but so did the price of industrial goods and food.
That’s because the COVID-19 pandemic has hit global logistics with sanitary restrictions and labor shortages, pushing freight prices to record highs and making imports more expensive.
The poor harvest has also led to a jump in the prices of some cereals.
A graphic on container freight rates rising to:
Is it going away?
Central banks in the 19 countries that use the euro expect price growth to slow once these imbalances between demand and supply are mitigated.
He believes the increase is partly explained by “base effects”, with prices unusually low a year ago as the pandemic closed businesses and kept people at home. They also cite a cut in the German value-added tax that was part of the government’s COVID-19 support package.
High levels of structural unemployment and an aging population in the euro area meanwhile act as a cap on its long-term growth and inflation prospects.
The ECB expects inflation to average 2.2 percent this year before reducing to 1.7 percent next year and to 1.5 percent in 2023.
Core inflation, which excludes energy and food prices and is seen as a better indicator of the underlying trend, settled at 1.6 per cent in August and is expected to average between 1.3 per cent and 1.5 per cent for the next two years. have hope.
For a graphic on ECB inflation forecasts:
Are the Hawks on board?
Yes. Even the most flamboyant member of the ECB’s board, Germany’s Isabel Schnabel, subscribes to the idea that “in all likelihood, inflation will subside as soon as next year”.
This is a far cry from 2011, when the ECB’s chief economist Juergen Stark raised the two rates by a combined 50 basis points, going against his own staff’s projections that inflation would ease.
Subsequently, Stark emphasized the risks “related to further increases in energy and commodity prices”, while Trichett declined to overemphasize core inflation, which painted a more benign picture.
Conversely, Schnabel said this week that “a premature monetary policy tightening in response to a temporary increase in inflation would affect the recovery”, while ECB President Christine Lagarde underlined sluggish core prices.
The head of Austria’s central bank, Robert Holzmann, takes the most radical view, arguing that price pressures may prove to be more persistent than currently thinking, so that the ECB can tighten policy earlier than expected.
As for the graphic on euro area inflation: it depends who you ask:
What if they are wrong?
The ECB has a dismal track record in forecasting inflation, having underestimated most price pressures over the past decade after underestimating them between 2009 and 2011.
Its economic models, like those of others, extend past to future, meaning that a decade of very low inflation could lead them to anticipate that prices will continue to water.
That’s why central bankers are on the lookout for any signs that a sudden rise in prices is feeding wages and expectations of consumers and businesses, potentially initiating an inflationary spiral—indeed, anything that “humps”. “Weakens the story.
A graphic on the ECB for a long overdue inflation:
no conclusive evidence
So far, there is no conclusive evidence that this is happening.
On the one hand, German consumers expect inflation to be 3.6 percent over the next 12 months, the highest level since the Bundesbank poll began polling.
And there are widespread reports of staff shortages, especially for restaurants and bars.
On the other hand, consumers appear reluctant to spend all the savings accumulated during the COVID-19 lockdown and the wage hike has been modest.
German unions’ initial bets for a 5 percent increase in salaries for regional government employees are lower than the 6 percent demanded in the previous round in 2019—and the final German wage rewards are usually much lower than the initial claim.
Eurostat data on Wednesday showed wages in the euro area actually fell 0.4 percent in the second quarter, following a 2.1 percent increase in Q1.
This uncertainty is why the ECB has postponed any decision on the future of its stimulus program until December.
“We will be very attentive to the autumn talks that are usually taking place in some countries,” Lagarde said last week. “But at this point in time, we don’t expect these increments … to be very strong.”
by Francesco Canepa
This News Originally From – The Epoch Times