German Inflation Eases Boosting Calls for Slower ECB Hikes
Despite a record-low German consumer price index (CPI) in December, forecasts for inflation in the eurozone are above December’s estimate of a 2.2% HICP inflation rate for both 2023 and 2024, according to the ECB. Combined with the euro’s fall to parity against the dollar, this could pose a problem for the ECB, who has been playing down the threat of a deflationary spiral, as it continues to hike interest rates.
Forecasts are higher than December’s estimates of 2.2% HICP inflation rate for both 2023 and 2024
Earlier this month, the European Central Bank (ECB) raised its inflation forecasts for 2023 and 2024 by 0.2 percentage points to 3.2% and 4.3%, respectively. While inflation is expected to peak at around the turn of the year, the ECB is sticking to the narrative that price growth will eventually fall below its target.
With the economy close to its potential real GDP, growth will slow and inflation is expected to remain high. However, the ECB still has room to hike rates. The central bank will terminate net asset purchases under its PEPP program by March 2022. Several Governing Council members, however, have pushed for a more significant reduction in asset purchases.
The impact of the recent surge in gas prices is difficult to gauge. This will depend on whether wholesale prices adjust for the changes, and how long utility price increases continue. But if wholesale price increases continue to rise, energy inflation will likely escalate.
ECB has played down the threat of a deflation
ECB president Mario Draghi said last week that the danger of inflation falling into a deflationary rut was limited, but the ECB would act if this was to happen. He said that the ECB’s Governing Council was committed to the ECB’s primary objective of price stability, but added that a low inflationary environment could thwart efforts to tackle unemployment and reduce debt.
Deflation would result in households delaying purchases. This would crimp demand and entrench a downward price spiral. It would also result in higher real interest rates, a key consideration for the ECB.
The ECB’s main interest rate has been set at a record low of 0.25 percent. This is partly because of falling energy prices, but the central bank also said it would not make a rush to adopt quantitative easing, a policy in which the ECB buys government bonds to inject money into the economy.
The ECB’s inflation target is below, but close to, two percent. But this is no silver bullet, as low inflation can hinder the euro area’s recovery, thwart efforts to reduce debt and thwart efforts to restore competitiveness.
Real wages are expanding by nearly 20% since the outbreak of the pandemic
During the COVID-19 pandemic, an estimated 8 percent of American workers saw their salaries rise. In the months following the outbreak, average wage growth was particularly robust. This has not been an economic standstill, but the Administration expects these anomalies to eventually dissipate.
The BLS has released several economic data sets, including the Employment Cost Index (ECI), which measures the average change in wages within industries and occupations. The ECI also enables comparisons between one industry and another, such as between health and non-healthcare sectors.
The BLS also has released a compositionally adjusted version of the same data set. This data set is the first to show average wages rising in real time during the pandemic, as well as the largest gains in non-healthcare fields. This is in addition to the BLS’s standard monthly reporting of wages.
The BLS also released the most comprehensive data on state level unemployment rates, including estimates for sex, race, age and geographic location. This data set also includes the most detailed state level employment statistics for both private and public sector workers. In the health sector, the ECI’s health sector indices indicate an increase in overall employment from July of this year to January of next year, but the percentage of Americans employed in the sector remains a fraction of its pre-pandemic high.
The euro’s fall to parity against the dollar also poses problems for the ECB
During the past few months, the euro’s exchange rate has sunk to its lowest level in 20 years. The euro is now worth about $1.25 per euro, which is about 80 euros less than it was in early 2002.
The euro’s depreciation has a negative impact on the euro area, which is already experiencing high inflation. A weaker euro means higher prices for imported goods, which increases inflation in Europe.
Central bankers are committed to bringing inflation down through higher interest rates. But higher interest rates can have economic repercussions, such as slowing economic growth. So, the ECB is in a tough position. It’s trying to support the euro but its power to do so is limited.
The ECB is worried about the effect of its plan to end bond-buying programs. It also wants to boost confidence in the euro. It plans to announce a new policy tool to fight fragmentation. This would limit adverse credit spread increases and counter disorderly market dynamics. But the size of the new program isn’t clear yet.