Eurozone Inflation Rises to Fresh Record, Against Expectations

Eurozone Inflation Rises to Fresh Record, Against Expectations



The eurozone’s inflation rate rose to a fresh record high in January, an unwelcome surprise for policy makers at the European Central Bank who have said they don’t expect to raise their key interest rate this year.

However, ECB officials and most economists were confident that the first inflation reading of the year would show a significant drop as earlier changes in Germany’s sales tax dropped out of annual comparisons.

Instead, figures released by the European Union’s statistics agency on Wednesday showed the annual rate of inflation picked up to 5.1% on a fresh surge in energy prices. Economists surveyed by The Wall Street Journal last week had expected to see a decline to 4.3%.

The ECB will announce its latest policy decisions Thursday, although little is expected to change ahead of its March meeting, when policy makers will discuss the implications of new forecasts for inflation and growth.

At its last meeting in December, the central bank raised its inflation forecast for this year, but said it expected the rise in consumer prices to slow as 2022 advances. It expected inflation to fall back below its target in 2023, and said that under those circumstances it was unlikely to raise its key interest rate this year.

By contrast, the Federal Reserve has indicated it is likely to raise interest rates a number of times this year, likely starting in March.

But with every inflation reading that is higher than anticipated, the ECB’s stance becomes more challenging to explain to households and businesses.

Investors are starting to have doubts about the ECB’s guidance, and began to sell eurozone government bonds when national inflation figures from Spain and Germany first hinted at the January inflation surprise on Monday. The 10-year German bund yield closed in positive territory for the first time since May 2019, maintaining this on Tuesday as well. According to analysts, bond prices now suggest that investors expect a small rise in the ECB’s key rate this year.

“The market is also clearly in the mood for challenging the prevailing ECB narrative,” wrote HSBC economist

Fabio Balboni

in a note to clients.

While the pickup in inflation during January was relatively modest, it counts as a major surprise. That is because economists had long expected to see a big step down in inflation during January as a result of what are known as “base effects” connected to changes in Germany’s sales taxes.

In July 2020, the government of the eurozone’s largest member cut its value-added tax rates for six months. That meant consumer prices from July 2021 onward were being compared with artificially low prices from a year earlier, exaggerating measured inflation. January was the first month in which that base effect was absent from the inflation figures, since the tax rates reverted back to their pre-pandemic levels at the start of 2021.

The removal of that distorting factor was apparent in the January eurozone inflation figures, with the annual rate of inflation for prices of manufactured goods slowing to 2.3% from 2.9% in December. However, that was offset by resurgent energy prices, which rose 28.6% in the 12 months through January, compared with 25.9% in the 12 months through December.

Frederik Ducrozet,

an economist and noted ECB watcher at Pictet Wealth Management, tweeted that it was the “largest upside surprise in the history of euro area flash…inflation releases.”

In common with other central bankers, ECB policy makers are reluctant to raise their key interest rate in response to interruptions in supply that they can do little to affect. However, they do worry that the longer inflation remains above their target, the greater the risk that households and businesses will grow accustomed to prices rising more quickly than its target rate, opening the way for a self-reinforcing series of higher pay deals and price rises by employers to cover their increased costs.

“Usually they say they don’t react to temporary price shocks, but this time the main concern is second-round effects,” said

Anna Titareva,

an economist at UBS. “Their concern is that the longer inflation remains high, the greater the risk that could feed into more permanent increases in inflation expectations.”

As prices surge, eurozone workers are facing a sharp fall in their real spending power, while their bargaining power appears to be growing. According to the ECB, wages in the three months through September were just 3% higher than a year earlier, lagging behind inflation. Figures released by Eurostat on Tuesday showed the eurozone’s unemployment rate fell to 7% in December, the lowest level recorded since the series began in 1998.

Write to Paul Hannon at [email protected]

Copyright ©2022 Dow Jones & Company, Inc. All Rights Reserved. 87990cbe856818d5eddac44c7b1cdeb8

Share:

Facebook
Twitter
Pinterest
LinkedIn
Rachel Meadows

Rachel Meadows

Trending topics news writer who enjoys cooking, walking her dog and travel.