Inflation is slowing in the Eurozone, but underlying pressures on prices remain

why does it matter

Although the European economy is more resilient than many forecasters had predicted, it has remained remarkably weak over the past 12 months, with inflation-adjusted wages and consumer confidence declining. Growth is expected to pick up, but further increases in interest rates could act as a brake on the economy.

Gita Gopinath The first deputy managing director of the International Monetary Fund said this week that the “inconvenient truth” is that central banks must remain diligent in lowering inflation rates “even if it means risking weaker growth”.

The same message is coming from the European Central Bank, which has already signaled the possibility of a rate hike in July and September. At the 10th Annual Central Bank Conference this week in Sintra, Portugal, Christine Lagarde, President of the European Central Bank, said: “Inflation in the eurozone is very high and is set to stay that way for a long time.”

Rapid interest rate increases have drawn criticism from political leaders such as Giorgia Meloni, the Italian prime minister, who derided the ECB’s “simplistic prescription of raising interest rates”. in a letter to Parliament on Wednesday.

Lucrezia Reichlin, a professor at the London Business School and former director general of research at the European Central Bank, said it “would be a mistake” to raise rates in September.

“There is a misconception that core inflation is driven by demand,” she said, but the small increase in June was the result of the lag time between the impact of previous price increases and the large declines in energy prices.

A small increase in core inflation “does not mean that the deflationary process has stopped,” said Riccardo Marcelli Fabiani, an economist at Oxford Economics. He pointed to lower inflation in the services sector in France and Italy, which were among the “growing indications of widening deflationary pressures”.

background

Inflation in the eurozone peaked in October at 10.6 percent, after energy and food prices rose last year after the coronavirus pandemic subsided and Russia’s invasion of Ukraine.

Price increases across the eurozone have slowed since then. France’s annual inflation rate fell to 5.3 percent in June from 6 percent in May. Italy’s interest rate fell to a 14-month low of 6.7 percent, down from 8 percent the previous month. Spain price fell to 1.6 percentthe slowest since March 2021. Government subsidies on gas bills helped keep the rate down.

Germany, Europe’s largest economy, saw its annual inflation rate rise to 6.8% from 6.3% in May. But analysts said the increase was almost entirely due to the reduction in subsidized train fares that the government put into effect in June last year. Inflation rates in Germany are expected to resume their decline in September.

Slovakia’s rate of 11.3 percent was the highest in the eurozone.

Despite expectations that inflation in Europe will continue to decline, the rate is still well above the central bank’s target of 2%. Efforts to achieve this goal prompted policymakers to raise interest rates, raising the deposit rate to 3.5 percent in June, the highest level in 22 years.

Before it started raising interest rates last year, the ECB’s main interest rate was negative 0.5 percent.

Why is inflation so persistent?

“The reason this continues is the fact that inflation works its way through the economy in stages, as different economic agents try to pass costs on to each other,” Ms. Lagarde said this week.

Although economists often focus on the risks of an inflationary wage price spiral, more evidence has recently emerged that the pursuit of company profits has led to higher prices despite significant declines in energy prices since last year’s peak.

Economists say The International Monetary Fund said this week.

The International Monetary Fund noted that “European companies have so far been more protected than workers” from rising costs. Adjusted for inflation, earnings were above pandemic level while workers’ compensation was 2 percent below trend in the first quarter of this year.