Eurozone inflation surged to its highest level in 10 years in August with further rises likely, challenging the European Central Bank’s benign view on price growth and its commitment to look past what it deems a temporary increase.
Consumer inflation in the 19 countries sharing the single currency accelerated to 3% this month from 2.2% in July, far above expectations for 2.7% and moving well clear of the ECB’s 2% target.
The increase was so large in part because some prices were much lower a year ago due to one-time factors connected to the coronavirus pandemic.
The surge was fueled by energy costs, but food prices also surged, while there were unusually large increases in the prices of industrial goods too, according to Eurostat, the European Union’s statistics agency.
Oil prices, following a price slump a year ago during the depths of the pandemic recession, contributed to a 15.4% rise in energy costs. With volatile fuel and food left out, core inflation was 1.6%. The latest figure also reflects other transitory factors, such as the timing of summer retail sales in France and Italy, and the expiration of German tax breaks on retail purchases.
Economists have cited a raft of additional reasons for recently higher prices in Europe. Some hotels and tourist businesses have marked up prices after the end of pandemic lockdowns, while supply chain disruptions and higher raw material prices have raised prices for producers of goods as economic activity has picked up.
Markets mostly shrugged off the data, with stocks rising and yields increasing just a basis point or two, suggesting the narrative of temporary inflation and ultra-easy central bank policy for years to come remains central.
Still, the numbers are likely to make for uncomfortable reading at the ECB.
The central bank has repeatedly raised its inflation projection this year only for the actual numbers to beat its forecasts, and price growth now seems likely to peak only in November.
With inflation in Germany, the eurozone’s largest economy and the ECB’s biggest critic, expected to approach 5% in coming months, the bank is likely to come under increasing public pressure to address price developments that are reviving long-dormant memories of runaway prices.
One-off factors?
The ECB argues that a slew of one-off factors including production bottlenecks related to the economy’s reopening after the COVID-19 pandemic account for the bulk of the inflation surge, and that price growth will quickly moderate early next year.
"The effects of reopening and supply problems could intensify in the next few months. But we suspect that they will begin to fade next year as global consumption and trade patterns return to something like their pre-pandemic norms," Capital Economics said in a note.
"We think the headline rate will drop to about 2% in January and trend down throughout 2022 to end next year at around 1%," it added.
Longer-term market-based inflation expectations are also holding well below 2%, even if they have moved steadily higher this year.
ECB policymakers agree and predict that inflation will languish well below the bank’s target for years to come, so they even reinforced their commitment last month to keeping monetary policy exceptionally loose to generate price pressures.
Speaking to Reuters last week, ECB chief economist Philip Lane argued that these inflation surprises still did not challenge his views about the temporary nature of price pressures as wage growth, a necessary component of durable inflation, remained muted.
While ECB policymakers are acknowledging that they underestimated price pressures in the near term, they continue to point to weak underlying inflation readings as supporting evidence for loose policy.
Core inflation, however, also surged in August with inflation excluding volatile food and fuel prices accelerating to 1.6% from 0.9%, while an even narrower measure that also excludes alcohol and tobacco, rose to 1.6% from 0.7%.
The ECB will next meet Sept. 9 and must decide on the pace of its bond purchases over the coming quarter. While some adjustment is possible, Lane argued that it would be at the margins as the ECB is committed to maintaining "favorable financing conditions."
After Tuesday’s reading, not all observers are quite so sanguine.
"This is not to say that there is no upside risk to the inflation outlook," ING economist Bert Colijn said. "So hold tight: inflation has the potential to go higher from here," he added.
The inflation question has been getting global attention, especially after annual U.S. consumer inflation reached 5.4% in July. The International Monetary Fund (IMF) says it sees inflation returning to pre-pandemic levels in most countries next year, but adds that there's high uncertainty about that. It cautioned that central banks may need to take action if price increases prove to be more persistent than expected.
Since many of the factors are temporary, economists do not expect the ECB to attempt to counter inflation by curtailing its stimulus programs or by raising interest rates. The central bank's most recent projections from June see inflation hitting 1.9% for all of this year, and falling to 1.5% next year. The ECB's governing council next meets Sept. 9 to review its policy stance.
Still, higher inflation is getting public attention, as witnessed by the front page of Germany's Bild newspaper trumpeting a "new inflation shock" after German figures came in at 3.4% based on inflation outcomes of several regions, the highest in 13 years.
Higher inflation expectations could play a role in wage demands by German unions in upcoming negotiations, according to Carsten Brzeski, global head of macro research at ING. One member of the ECB's governing council, Germany's Jens Weidmann, has warned that inflation could go as high as 5% and then decline, although the future path is uncertain.
Inflation has been low across the developed world for years, with economists theorizing that causes could include digitalization, aging populations and global competition in labor markets.