Analysis-Europe's inflation problem will linger for years to come
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[December 06, 2022] By
Balazs Koranyi
FRANKFURT (Reuters) - Euro zone inflation may have peaked but will
subside so slowly that it could be years before it gets back to the
European Central Bank's 2% target, keeping pressure on the ECB to
tighten policy well into 2023.
Having raised interest rates by a record 200 basis points since July,
the ECB has already taken a giant step towards taming inflation which
hit 10.6% in October before easing last month to 10.0% - still five
times the target level.
Pipeline pressures remain abundant, however, with energy prices still
sky-high, unemployment at record lows, and wage growth accelerating.
Government stimulus measures are working against the ECB's policy
tightening, and too much of the energy price rise has seeped into the
broader economy through second-round effects, fuelling underlying price
growth.
Meanwhile, a recession that was expected to ease inflationary pressures
is now seen milder than feared.
All of this suggests inflation will ease back from record highs only
slowly in the early months of 2023, with underlying inflation, more
closely watched by some ECB policymakers than the headline figure,
remaining stubbornly high.
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"The core inflation rate is unlikely to peak until mid-2023 and will
only fall slowly thereafter," Commerzbank economist Christoph Weil said.
"Against this backdrop, the ECB's goal of pushing the inflation rate
back to just under 2% on a sustainable basis seems a long way off."
Graphic: Euro zone inflation.
If disinflation proves too slow, firms and consumers may lose confidence
in the ECB's commitment and adjust their wage- and price-setting
behaviour to reflect higher inflation, perpetuating rapid price growth.
While that has not yet happened, longer term inflation expectations are
uncomfortably high and continue to trend up. A key market-based
indicator, often cited by the ECB, now stands at 2.4%, well above the 2%
target, and has moved up even as policy is tightened.
The ECB's new projections, due out next week, are set to show inflation
above target through 2024 and only falling to 2% in 2025.
"The second-round effects will drive inflation next year and in 2024,"
ECB Chief Economist Philip Lane said.
RECESSION TOO MILD?
A recession was set to do some of the heavy lifting in easing price
pressures but the downturn may be more benign than feared, a raft of
recent indicators - from confidence data to output figures - suggest.
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A customer shops in a supermarket in
Nice, France, August 18, 2022. REUTERS/Eric Gaillard/File Photo
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Gas storage facilities are full, meaning energy rationing is
unlikely, and governments are helping households and businesses via
subsidies. Supply bottlenecks, which drove inflation as economies
emerged from the pandemic, are easing.
"The current situation remains dire, but firms and households are
now seeing the light at the end of the tunnel, becoming more
optimistic for the future," Katharina Koenz at Oxford Economics
said. "A robust labour market should support households through the
continuing squeeze from energy prices."
The buoyant labour market may be a problem.
At 6.5%, unemployment is at a record low as firms, keenly aware of
how tough it was to get workers back after COVID-19, avoid letting
people go.
"We think companies will be reluctant to lay off workers as they
struggled to hire people in recent quarters," J.P. Morgan's Raphael
Brun-Aguerre said.
Wage growth, a precondition of durable inflation, is accelerating
meanwhile, leaving policymakers with a dilemma.
Some catching-up is necessary after this year's rapid rise in
consumer prices reduced real incomes. But it is not evident that
after a few years of above-trend growth, wage-setting will fall back
in line with the ECB's target.
"Wage growth is likely to reach around 4% at the end of this year
and stay there next," Bank of America Merrill Lynch said. "Hawks
will try to label that as evidence of second-round effects from
inflation. We are not convinced."
Added up, the pipeline pressures suggest the ECB is far from done
with rate hikes and its 1.5% deposit rate could still double before
its job is done.
![](http://archives.lincolndailynews.com/2017/Jul/22/images/ads/current/rohlfs_lda_072017.png)
"I think starting to talk about where we're going to end up is
probably premature and I can see scenarios where we go beyond 3%,"
ECB policymaker and Irish central bank chief Gabriel Makhlouf told
Reuters in an interview, referring to market pricing that point to a
peak rate just below 3%.
(Additional reporting by Padraic Halpin in Dublin; Editing by
Catherine Evans)
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