Elevated inflation, if left unaddressed, could cause a de-anchoring of inflation expectations, an increase in risk premia, greater price distortion and hence longer-term costs for the economy. Although at first glance, central banks face a dilemma - hiking interest rates to lower inflation at the risk of causing an increase in unemployment or focusing on the labour market and accepting the risk that inflation stays high for longer -, they can only choose between acting swiftly or face an even bigger challenge later to bring inflation back under control. Recent statements by officials of the Federal Reserve, the ECB and the Bank of England acknowledge the need to act but their decisions and guidance are very different and reflect the differences in the macro environment.
Faced with multiple pressures on prices, the United Kingdom has seen a sharp increase in inflation; CPIH hit 6.2% in March[1]. For households, this acceleration has resulted in a considerable deterioration in purchasing power. In real terms – that is, inflation-adjusted – the trend in wages was clearly negative (-1%) year-on-year in February 2022. However, bonus payments have offset this reduction, with wages including bonuses rising slightly (0.4%). The abrupt slowdown in real wage increases over little more than a year (in spring 2021, they were growing at 6%) has resulted in a collapse in consumer confidence, which in April fell to a near-record low of -38 points on the GfK index, close to the low point during the economic and financial crisis of 2008
Elevated inflation has become widespread. It raises the risk of further price increases because companies may be more inclined to raise prices when most others are doing the same. This would make high inflation more persistent, implying that it would take more time for inflation to converge back to target. Persistently high inflation could weaken the credibility of the central bank and cause an un-anchoring of long-term inflation expectations. To pre-empt such a development, monetary authorities could decide to tighten policy aggressively. Research by the Federal Reserve shows that US inflation has become more persistent. This helps to understand the increasingly hawkish rhetoric of Federal Reserve officials and their insistence on the need to frontload monetary tightening
After a modest growth in 2021, Malaysia’s economy is set to recover more strongly in 2022. It will be supported by firm domestic demand, an expansionary fiscal policy and the reopening of Malaysia’s borders to tourists. The country is an exporter of commodities – mainly oil and palm oil – and should benefit from higher international prices, without being directly affected by the conflict in Ukraine. Thanks to the additional revenue from higher oil prices, the government should be able to take on most of the burden of higher inflation to prevent problems for households whose finances have already been weakened by the 2020 crisis. Another key uncertainty regarding economic growth is how long and how severe Chinese lockdowns will be, since they could drag down Malaysian exports.
French inflation hit 4.5% y/y in March according to the final INSEE estimate, due mainly to another jump in energy costs (up 9% in March alone, a 29.2% increase year-on-year). At the same time, this inflation appears to be starting to bite when it comes to consumer spending on goods: having fallen significantly in January (-2% m/m), this saw only a limited recovery in February (+0.8% m/m). The latest INSEE survey of household confidence was anything but reassuring about the prospects of a short-term rebound. Consumer confidence has fallen sharply, particularly because of fears of further price increases: the balance of opinion on the outlook for prices rose by 50 points, taking it to record levels.
Inflation in Italy reached 6.7% y/y in March, the highest level since July 1991. In addition to the spectacular rise in energy prices (electricity, gas & fuel) – up 50.9% y/y – there are now significant increases in prices for food products (+5.8% y/y), furniture (+8% y/y), as well as for the hotels & restaurants sector (+4.6 % y/y). That said, two consumption items are still in deflationary territory: education (-0.5% y/y) and communication services (-2.9% y/y). Nonetheless, the hardest part has yet to come: the latest PMI survey for March showed once again a significant increase in input prices, which was the strongest on record (+6.7 points to 81.5). This will feed through to higher consumer prices: this PMI index is indeed very well correlated with the CPI.
Inflation continued to rise in early 2022 to the point that it began to erode household confidence in March. These purchasing power problems foreshadow a decline in consumer spending. With fiscal support measures limiting the increase in inflation (by nearly 2 percentage points in April), growth is expected to remain slightly positive (0.3% in Q1 and 0.1% in Q2 according to our estimates).
Sweden has bet heavily on renewable energy sources, a strategy that is now paying off at a time when oil and gas prices are soaring. Although accelerating, Sweden’s inflation rate is still one of the lowest in Europe, at a little more than 4%. For Swedish households, the resulting loss of purchasing power has been mild, and partially offset by government support measures. But that is not the biggest worry: by invading Ukraine, Russia has shifted Swedish public opinion and rekindled the debate about joining NATO.
Unlike many central banks around the world, the Moroccan monetary authorities decided to maintain their key rate unchanged at 1.5%. Although inflation is accelerating, the surge is recent and relatively mild. In 2021, consumer prices rose at an average annual rate of only 1.4%. In February 2022, they were up 3.6% y/y and the situation will only get worse given the pressures on global commodity markets and the drop-off in national agricultural production. Three quarters of the acceleration in inflation in recent months reflects higher prices for food (+5.5% in February 2022) and transport (+6%), essentially due to external factors. Excluding these two categories, the growth in prices was less than 2%. Domestic pressures are mild
An exceptionally high number of Eurozone companies plan to raise selling prices. It is unlikely that, at this stage, unit labour cost growth would already be a key driver. Rising input costs and strong demand are playing a crucial role, whereby well-filled order books make it easier for companies to increase their prices. Selling price expectations of euro area companies are much higher than what would be expected based on their historical relationship with input prices and order book levels. It seems that when more companies are raising prices, others will be inclined to do the same. This broad-based nature of the increase of inflation could slow down the reaction of inflation to slower demand growth.
Rising inflation has eroded household confidence in Spain, which in March reported the sharpest drop since the European Commission’s statistical series began in July 1986. So far, business confidence is holding up better according to PMI and European Commission surveys. Yet there are clear signs of an economic slowdown to come: the new orders component of the PMI index has declined due to a sharp deterioration in external demand. Another notable change is the extension of goods delivery times in the manufacturing sector (the PMI index was down 9.1 points to 22.4). It is now at approximately the same level as in November 2021, the worst month on record for the current statistical series.
Countries neighbouring Russia and Ukraine are more exposed than those in Western Europe. Among the latter, there are differences, with Germany and Italy being more dependent on Russian gas than France, Spain or Portugal. The countries that import the most from Russia are also the most dependent on Ukrainian imports. The exposure of European countries to Russia and Ukraine, and their vulnerabilities to the economic repercussions of the war between these two countries, result primarily from the high weight of their imports of Russian energy supplies and Ukrainian food and agricultural products
A priori, rising inflation and inflation expectations, reflecting robust growth in demand and economic activity, should boost household spending by reducing real interest rates. Today’s situation is different. In many advanced economies, inflation is exceptionally high and to a considerable degree explained by negative supply shocks. In the EU and the euro area, household confidence recorded a big drop in March. Although unemployment expectations have increased, the main reason seems to be concern about high and rising inflation. Eurozone consumer confidence measures provide information about spending up to three quarters into the future. Given their recent decline, one should expect below-average consumer spending growth over the coming months
Eurostat’s flash estimate puts eurozone inflation for March at 7.5% y/y, representing another very substantial increase (up 1.6 points on the February figure). Inflation continues to be driven mainly by energy prices – the energy component contributed 4.9 percentage points to this figure, thus explaining 65% of the total – but the other components (food, manufactured goods, services) are also seeing increases and each contributed around one point. Thus, inflation is getting more widespread and all eurozone countries have been affected by its recent acceleration, albeit to varying degrees.
Although the war in Ukraine is casting shadows on the global economy, the Federal Reserve announced that it would rapidly normalise US monetary policy. The Fed’s main arguments for taking action include surging inflation, which is also spreading widely, as well as tight labour market conditions and tensions over wages. As the self-sustaining nature of price increases is still open for debate, the projected tightening of monetary policy looks surprisingly strong. In an economic environment accustomed to cheap borrowing costs, the Fed’s move is not without risks regarding the future path of activity.
After a record contraction in the economy in 2020, South Africa’s GDP grew by 4.9% in 2021. This was the highest growth rate since 2007. The strong recovery in the first half of 2021 was held back by rioting over the summer and the return of health protection measures in the face of the Omicron variant in the fourth quarter of 2021. The pace of recovery is likely to continue to slow, with GDP forecast to grow by 1.3% in 2022, according to our estimates. Economic activity will remain structurally constrained by weak potential growth. Inflation keeps accelerating. By the end of 2021, inflation had hit 6% year-on-year (3
The FOMC has started a new tightening cycle and its members project 6 additional increases in the federal funds rate this year and 4 more in 2023. This hawkish stance is unsurprising. After all, the policy rate is very low, inflation is exceptionally high and the economy is strong. Given the Fed’s dual mandate, the pace and extent of rate hikes will depend on the evolution of inflation as well as the unemployment rate. Previous tightening cycles suggest that concerns about the risk of an increase in the unemployment rate have played an important role in the decision to stop hiking. The central bank will have to hope that inflation has dropped sufficiently by the time that this risk would re-emerge.
French GDP growth remained positive in early 2022, as illustrated by the relatively stable INSEE’s survey results through February, in terms of households, businesses and employment. Inflation rose significantly in February, up 3.6% y/y, but it was held down by the stability of regulated gas prices and the cap on electricity prices, which rose only 4%. According to the INSEE’s most recent economic update, inflation would have hit 5.1% without these control mechanisms.
Since its launch, the ECB’s asset purchase programme has had, through various transmission channels, a significant impact on financial markets, activity and inflation. In recent months, doubts about the positive effects of additional purchases and concerns about possible negative consequences have increased. Against this background, the ECB has cut the link between the timing of the end of net asset purchases and the rate lift-off. This is a welcome decision that increases the governing council’s optionality. The new staff macroeconomic projections remind us of the pervasive uncertainty we are facing. In such an environment, monetary policy can be nothing else than data-dependent.
The war in Ukraine has caused a jump in commodity prices that will trigger a further increase in inflation and will weigh on GDP growth. Unsurprisingly, the narrative that stagflation is in for a comeback is gaining ground, as shown by the increasing number of media references to this topic. Stagflation is a multi-year phenomenon of high inflation and a high rate of unemployment. Although inflation is high, the other conditions are clearly not met today. Monitoring financial markets developments is useful in gauging whether stagflation risk is on the rise. This can be done by comparing the developments in breakeven inflation and the high yield corporate bond spread
In Japan, possibly more than anywhere else, it is important to distinguish the dynamics between headline and core inflation. Headline inflation – at 0.5% in January – is bound to rise further, led by higher energy prices. By contrast, core inflation is still deeply in deflationary territory, and this trend is amplifying. Excluding perishable food products and energy, the consumer price index (CPI) declined by 1.2% year-on-year in January, the biggest decline since March 2011. The services sector even has reported the strongest deflation since 1970 (-2,8%), mainly due to the sharp drop in mobile phone charges, down more than 50% since March 2021. Medical services were also down (-0.8% y/y), as was durable household goods (-3,0% y/y), and leisure goods (-1.1% y/y)
The question of the persistence of high inflation matters because it will determine the extent of monetary tightening necessary to bring inflation under control. Key factors are growth of unit labour costs, the price elasticity of demand and its mirror image, the pricing power of companies. The latter two are conditioned, at least in part, by the cyclical environment: when growth is very strong, price elasticity of demand will be lower and pricing power higher than normal. A regression analysis between the PMI output prices index and the PMI input prices index (explanatory variable) shows that recently in the US and the euro area, pricing power has increased quite significantly
As shown on our Pulse, the sharp increase in inflation has continued in January, with the harmonised index of consumer prices (HICP) up 6.1% y/y in January. Although the details of last month’s inflation have not yet been revealed, energy prices should remain, unsurprisingly, the main driver of higher consumer prices. The energy element of the HICP recorded a jump of 40.2% y/y in December 2021, whilst the sector’s production prices nearly doubled (+95.9% y/y) between December 2020 and December 2021.
Although Germany is not the eurozone country experiencing the highest inflation rate, the trend is nevertheless uncomfortable. Consumer prices posted another hefty rise in January (+5.1% y/y, harmonised index), although this was less than in December 2021 (+5.7%). The end of positive base effects – caused by the end of the VAT rate cut in place in the second half of 2020 – did not therefore result in a marked fall in inflation.
Usually close, French and German inflations, measured on a comparable basis by Eurostat’s harmonized index of consumer prices (HICP), have diverged sharply since the beginning of 2021, with inflation on the other side of the Rhine largely exceeding that in France. In November 2021, the gap reached +2.6 percentage points compared with an average of +0.2 pp since 1991. This difference is, for a part, due to a VAT effect: the decrease in the German rates in the second half of 2020 initially pulled down German inflation but the return to their previous level reverted that trend in 2021. In January 2022, with the end of this VAT effect, German inflation fell back quite significantly (to 5.1% y/y according to Eurostat’s flash estimate, from 5.7% in December) but is still very high
