Inflation is back, but is it here to stay?

We see inflation returning to the Euro zone and the USA. In January 2017, Germany’s prices increased by 1.9% per year and in Spain by 3%. Last December for one year, prices are up by 1% in the Euro zone, compared to 0.6% for the preceding month. The same trend continues in the USA – during 2016, prices rose on average by 1.3%, which is a lot more than during 2015, when prices only increased by 0.1%. However, inflation is slowing down in emerging countries, especially in Russia and Brazil which are undergoing a recession.

These figures, never seen since 2013, would suggest that inflation has – finally – returned. After years of fearing that deflation would aspirate our economy, inflation is welcomed as a sign of economic recovery. However, as explained below, this phenomenon must be interpreted with caution.

  • Base effect largely explains the huge price increase in petrol. That is to say, January’s 2017 petrol prices seem high only because they were so low a year ago. And as the shale gaz extraction takes off again (and floods the global market), prices will again stabilize, and maybe even decline.
  • There are strong differences in consumer price indexes amongst countries. For example in the USA, Germany, and Spain, consumer price indexes have increased sharply in January, but in Italy and France, inflation remains moderate (0.2 % and + 1.4 % respectively).
  • Long-term underlying inflation is low. It is influenced by job-market tensions and wage increases. It is true that tensions are appearing in Germany and in the USA, where job markets are close to saturation. However, unemployment remains high elsewhere, and therefore wages are unlikely to increase. Indeed in France, prices (except for food and energy in 2017) are decreasing.
  • It could be argued that the current trend of wage de-indexation and inflation’s return could weigh adversely on households’ purchasing power and on firms’ margins. However, for the time being confidence seems to be on the rise. The main PMIs (purchasing manager indicators) are well above 50% on manufacturing and services, signifying that economic activity is be expanding.
  • The current raise of sovereign spreads within the euro zone could be imputed to inflation. However, this raise could also be imputed to political incertitude facing many European countries this year. France will hold presidential and legislative elections this spring and Italy’s political situation is uncertain. Netherland’s elections this March are Europe’s first test as to its political future. Opinion polls suggest that Geert Wilders’s anti-European and anti-immigration party (PVV) could double its seats in the House of Representatives. Even if this is not enough for PVV to hold a majority, it would be for it to become an inescapable partner in a coalition formation. Therefore PVV, finding itself in a strong bargaining position, could demand a referendum on Netherland’s exit from the European Union.

Central banks are reacting to today’s inflation differently. In the Euro zone, the European Central Bank (ECB) believes that the inflation is temporary and will wait before enacting any anti-inflationist policy. The Bank of England (BoE) is caught under two cross-fires. One the one hand, it has raised its growth forecast to 2% and maintains its inflation forecast to 2.7% for 2017. It is true that the strong devaluation of the pound sterling, provoked by Brexit, brings strong inflationary pressure. On the other hand, the BoE believes that job-market tensions are too low to provoke inflationary wage increases. Therfore the BoE is waiting to see how the English job market evolves before enacting any inflation-corrective measures. However, the BoE does seem to have terminated its policy of lowering its intervention rate. As for the Federal Reserve (Fed) in the USA, it did not raise the intervention rate last December because it estimates that short-term inflationary risks are under control. However, the FED is uncertain as to possible intervention rates in the future because the measures promised by President Trump for economic recovery, such as tax decrease, increase in infrastructure expenditure, and a protectionist economy, are likely to overheat the economy and thus provoke durable inflation.

After years of absence, will inflation remain durably in the euro zone? BIPE believes that this heavily-waited-for inflation is only temporary, because the factors explaining the recent price increases are only economic conjectural fluctuations. Instead, BIPE believes that the current reduction in over-capacity taking place, mainly in Asia, is more likely to encourage investment than inflation.

Renaud Muller, Macroeconomist – 14/02/2017

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Publié le: 14-02-2017