Friday, September 22, 2023

Europe’s inflation problem will last for years


If disinflation proves to be too slow, businesses and consumers could lose confidence in the ECB’s commitment and adjust their wage and price-setting behavior to reflect higher inflation, thereby perpetuating rapid price growth.

Although this has not happened yet, long-term inflation expectations are uncomfortably high and continuing to trend higher. A market-based benchmark frequently cited by the ECB is now at 2.4%, well above the 2% target, and has risen despite tightening monetary policy.

The ECB’s new forecasts, to be published next week, expect inflation to remain above target by 2024 and fall to just 2% by 2025.

“The secondary effects will boost inflation next year and in 2024,” said Philip Lane, chief economist at the ECB.

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A recession that is too gentle?

A recession should ease some price pressures, but the slowdown could be milder than feared, a range of recent indicators, from confidence data to production numbers, suggest.

Gas storage facilities are full, so energy rationing is unlikely, and governments are supporting households and businesses with subsidies. Supply constraints that fueled inflation as economies emerged from the pandemic are easing.

“The current situation remains bleak, but companies and households are now seeing the light at the end of the tunnel and are more optimistic about the future,” said Katharina Koenz of Oxford Economics. “A robust labor market should help households cope with ongoing energy price pressures.”

The buoyant job market can be a problem.

At 6.5%, unemployment is at an all-time low as companies, aware of how difficult it has been to rehire workers in the wake of COVID-19, refrain from laying off workers.

“We expect companies to be hesitant to lay off workers as they have struggled to hire in recent quarters,” said JP Morgan’s Raphael Brun-Aguerre.

Wage growth, a prerequisite for sustained inflation, is now accelerating, presenting monetary policymakers with a dilemma.

After the rapid rise in consumer prices this year reduced real incomes, the lost ground must be made up again. However, it is not foreseeable that wage setting will be in line with the ECB’s objectives again after several years of above-average growth.

“Wage growth is expected to be around 4% by the end of this year and remain there next year,” Bank of America Merrill Lynch said. “Proponents of tightening will try to dismiss this as evidence of inflationary side effects. We are not convinced.”

Overall, the ongoing pressures suggest that the ECB is far from finished raising interest rates and that its 1.5% deposit rate could double before it finishes its work.

“I think it is probably premature to talk about where we will end up and I can imagine scenarios where we go above 3%,” said Gabriel Makhlouf, head of monetary policy at the ECB and the Central Bank of Ireland , told Reuters interview. , citing market prices that suggest a maximum rate of just under 3%

Nation World News Desk
Nation World News Desk
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