EUROPEANS brace for a costly summer that will test central bankers’ resolve for stimulus as the region’s delayed economic recovery sparks growing demand.
The question for officials from Frankfurt to Warsaw is whether the acceleration in inflation will last long enough to alter long-term expectations of businesses and households. If so, it could create a self-reinforcing cycle in which higher prices lead to higher wage demands – despite high unemployment – which fuel price increases even more.
Price pressures could also embolden central bankers who believe policy has been too loose for too long, by holding potentially strained rate-setting meetings later this year. While the official line is that the inflationary spike will be temporary, recent data is fodder for those worried about the risk of being wrong.
“All cyclical and structural factors add up and point to a trend reversal,” said Gertrud Traud, chief economist at Helaba in Frankfurt.
“Once German inflation hits 3%, the unions will ask, ‘What about the workers? “”
The prospect of faster inflation was evident in a series of reports on Tuesday, after factories raised prices at the fastest rate in nearly two decades due to rising costs and dwindling inventories.
It fuels the buyers. Consumer price growth reached 2% in the euro area – technically above the European Central Bank (ECB) target – for the first time since 2018.
In Poland, it was more than double. The Bundesbank estimates that German inflation could reach 4% this year.
The reading of 4.8% in Poland – which is not part of the euro zone – highlights growing risks. Authorities fear that 5% may be a tipping point fueling public inflation expectations, according to people familiar with the thinking of the central bank and government officials.
There are few signs that the squeeze in global supply is easing. Asian manufacturers, component makers for much of the world, slowed down activity last month as countries battled virus outbreaks.
Several factories in Thailand have temporarily closed to stem outbreaks, Taiwan has reported record weekly deaths from the virus and Malaysia has started a two-week nationwide lockdown.
In Europe and elsewhere, the increase in bankruptcies when tax support to businesses is removed could exacerbate supply problems.
The Organization for Economic Co-operation and Development (OECD) said this week that while global price pressures are expected to ease towards the end of the year, there are “upside risks” in the longer term.
The ECB staff forecast in June is unlikely to show anything that would prevent another quarter of a pandemic emergency purchase program or PEPP purchase.
In March, they had core inflation well below the target over the forecast horizon, economists said.
Despite the impressive jump in Poland, the central bank believes that the surge in consumer prices is short-lived. It has so far chosen not to follow its regional peers, most notably Hungary and the Czech Republic, in signaling impending interest rate hikes.
Elsewhere, Iceland’s central bank last month became the first in Western Europe to tighten monetary policy since the pandemic by raising interest rates, thus acting at the head of a spike in inflation. Norway’s central bank has also indicated it is on track to start tightening.
At the ECB, whose job is complicated by managing by far the region’s largest currency area, with divergent growth prospects in different members, officials insist that supply shortages will be overcome and that year-to-year price changes will ease. figures on the front page.
Market-based measures indicate that price increases in the euro area will on average be below target for years to come.
Energy costs are an important factor compared to a year ago, as prices fell when travel was halted in 2020. The measure of core inflation in the euro area, which excludes l energy, food and tobacco, was much more moderate by 0.9%.
“I would be very, very surprised if Europe got a widespread price increase,” said Paul Donovan, chief economist at UBS Global Wealth Management.
“Should central banks tighten their policies because the price of toilet paper rolls suddenly went up?” No of course not.”
The persistent fear of central bankers is, however, a “de-anchoring” of inflation expectations. That would force them to consider tightening monetary policy – a tough decision when unemployment is above pre-pandemic levels and heavily indebted governments are dependent on low borrowing costs.
The alternative would be to let inflation soar for a while. This is arguably valid after the many years when price growth has been too weak, but it risks echoing a strategy of the 1960s that ended badly a decade later.
“Now is not the time to worry about inflation,” Angel Gurria, outgoing OECD president, told Bloomberg Television this week.
“Although it should always be kept in mind.” – Bloomberg
Paul Gordon and Alexander Weber write for Bloomberg. The opinions expressed here are those of the authors.