Inflation has continued to accelerate, at 5.8% y/y in June, and has not yet reached its peak. Most significantly, the energy component saw a further monthly rise of 5.3% in June, having already risen by 9% in March. Not only had the initial shock not yet fully passed through into other prices (food, manufactured goods, services), but this new increase signals a further acceleration in inflation, particularly in the food component which suffered the most from the initial shock (1.4% increase month-on-month and 3.1% over 3 months): In June, this food index has increased by 5.7% y/y, below July 2008’s 6.4% peak, but should rise above and reach 9% in December 2022, according to our forecasts.
The level of activity in the US and the euro area is very high but growth has already slowed down significantly and quarter over quarter growth should remain low for the remainder of the year. Worries about the cyclical outlook are on the rise due to a combination of elevated inflation, geopolitical uncertainty and monetary policy tightening. Survey data on input prices and delivery times have eased but the levels are still very high. Wage growth remains strong in the US and is picking up in the euro area, creating concern that inflation would decline more slowly than expected. In addition, assessing the true state of demand has become very difficult.
Inflation’s unexpected rebound in May forced the Federal Reserve (Fed) to accelerate the normalisation of its monetary policy. In mid-June, the Federal Open Market Committee (FOMC) decided to raise the fed funds rate by 75 basis points (bp). At the same time, the Fed began to shrink its balance sheet through Quantitative Tightening (QT). For the moment, the US economy is holding up well, supported by robust fundamentals such as employment. Yet activity is beginning to slow under the impact of tighter lending conditions and deteriorating global economic prospects. The US economy will come under fierce pressure as it navigates towards a hard or soft landing.
Since early 2022, inflation has been rising, albeit moderately, for the first time since 2014, while growth contracted in Q1. The yen has depreciated sharply due to the Bank of Japan’s very accommodating monetary policy, which is out of step with the other major central banks, who have already begun to tighten their monetary policy. In June 2022, BoJ Governor Haruhiko Kuroda still thought it was “necessary” to maintain a yield curve control policy to boost core inflation to a “stable and sustainable” level. Yet currency depreciation aggravates imported inflation and further erodes household purchasing power. A few weeks before the legislative elections of 25 July, the government is likely to reinforce measures to support household purchasing power.
Until May, Eurozone growth has been relatively resilient to the series of shocks that have swept the region, but its pace should slow more significantly in the months ahead. We cannot rule out the possibility of a recession, even though that is not our base case given the numerous sources of growth: post Covid-19 catch-up potential, surplus savings, investment needs and fiscal support measures. Our scenario appears to signal stagflation (inflation will be much higher than growth in 2022 and 2023), but with the big difference that the unemployment rate is not expected to rise much. The ECB is preparing to begin raising its key policy rates to counter the inflationary shock. We are looking for a cumulative 250bp increase in the deposit rate, bringing it to 2% by fall 2023.
Germany is one of the Eurozone countries hit hardest by the Russia-Ukraine war, which is leading towards feeble growth prospects and high inflation. German GDP is expected to barely increase by 1.3% in 2022, compared to a Eurozone average of 2.5%. Average annual GDP growth will remain 0.9% below the year-end 2019 level. At the same time, inflation is expected to reach 8.1% in 2022, driven up by high energy prices. Between the minimum wage hike promised by the government and expected wage increases in many sectors, wage growth should accelerate strongly in 2022, but may not be sufficient to offset the inflationary shock.
The French economy is stuck between three developments with different effects: an inflation shock that is denting consumer spending, a negative supply shock (supply constraints in industry) and the lifting of public health restrictions (benefiting growth as of the second quarter, having held it back in the first quarter). Government measures that have limited inflation were unable to prevent negative growth in the first quarter. However, the positive impact of the lifting of public health restrictions and a rebound in purchasing power should allow for a recovery towards positive growth in the third quarter (+0.3% q/q).
With an energy mix comprised of nearly 90% fossil fuels, the Netherlands have been hit by the full brunt of the sharp rise in oil and gas prices since the outbreak of the Russia-Ukraine war. As a result, the Netherlands has one of the highest inflation rates in Europe. Even so, household consumption is resilient, and the majority of companies esteem that business will remain vigorous in the months ahead. Thanks to this strong performance, the government has been able to focus on a limited series of support measures while continuing to reduce the debt of public administrations. Yet the Netherlands also faces another type of inflation that is just as alarming: house price inflation
After surging above 10% this spring, inflation will be the main headwind hampering Greek GDP growth in 2022. Yet the economy has proven to be resilient so far. Unemployment has been at the lowest rate since 2010, and GDP has rebounded robustly since the end of lockdown measures in 2020. A recession is unlikely this year, especially since tourism is primed for a solid summer season. On 20 August 2022, Greece will officially exit the European Commission’s enhanced economic surveillance programme, which it entered in June 2018. In May, the country also repaid the last of the IMF loans (EUR 1.9 bn) contracted during the 2011 crisis. Eleven years later, Greece is taking another step towards the normalisation of its economic system.
Inflation continues, driven by factors specific to the UK economy. On the one side, we have a labour market with full employment, favouring wage rises. On the other side, we find the UK economy’s exposure to the consequences of the invasion of Ukraine putting considerable pressure on energy prices. Despite increasing its policy rate early, and then building on this with a succession of further hikes, the Bank of England is struggling to control rising prices. The government has little choice but to intervene to bolster household purchasing power. The economy is already slowing, and there is a risk it will worsen.
Once protected by the logic of “whatever the cost”, household purchasing power in Europe is now threatened by inflation. After the pandemic, public policies are being solicited once again to help reduce the loss of purchasing power, albeit without really succeeding. In 2022, the real disposable income of Eurozone households is expected to decline by about 2.5%. Consumption is still rising, but only because the household savings rate is declining, a trend that masks extremely diverse situations.
The Covid-19 pandemic weakened Indonesia’s economy. Two years after the crisis, real GDP has returned to 2019 levels, but the labour market is still weak, the poverty rate is higher than before the crisis and investment remains subdued. According to the World Bank, the pandemic’s lasting impact on education and the labour market will cost the country 0.1 points of its long-term growth potential. Today, Indonesia must deal with a new unfavourable economic environment as commodity prices have dramatically increased due to the conflict in Ukraine and sanctions against Russia. Although growth is bound to be squeezed by the Ukrainian conflict, Indonesia’s external accounts should remain healthy and inflationary pressures should remain moderate
After an unprecedented contraction in activity in 2020, the strong rebound in 2021 did not allow South Africa to return to its pre-crisis level of GDP contrary to most emerging economies. In 2022, activity should remain subdued and growth below 2% in the medium term. The economic outlook remains largely constrained by the need for fiscal consolidation in order to contain the high risk of debt distress, the tense socio-political climate, and structurally by strong infrastructure constraints, first of which the electricity supply. The shock induced by the conflict in Ukraine is also exerting significant pressures that could make fiscal consolidation efforts difficult
Inflationary pressures in France continue to grow. The INSEE retail survey for May set a new record, with a balance of opinion on expected selling prices that reached 43, from 36 in April and a long-term average of -2. The housing development sector saw the biggest share of companies forecasting price increases. This echoes the increase in building materials prices and reflects strong household demand: on average over the last three months nearly 25% of households in the INSEE consumer survey have indicated that they intend to spend on housing development (against a long-term average of 21%). This said, the proportion is down on the figure of 26.7% reported for October 2021, suggesting that this demand has wilted somewhat in the face of strong inflation
Historically, there is a close relationship in the US and the euro area between, on the one hand, a measure of price pressures based on survey data on manufacturing delivery times and input prices, and, on the other hand, core inflation. The recent flash purchasing managers’ indices show that price pressures may be peaking, thereby providing hope that inflation will follow in the not-too-distant future. This will focus the attention to the speed of decline in inflation. A very slow process would be highly discomforting, raising fears that ever-higher interest rates would end up causing a recession. Everybody wants slower growth to bring inflation under control, but nobody wants the growth engine to stall.
The sharp rise in energy prices since April 2021 has been the main driving force behind the current surge in Eurozone inflation. The outbreak of war in Ukraine on 24 February accentuated this trend, sending the energy component of the harmonised index of consumer prices (HICP) up 44.4% y/y in March 2022. Faced with this situation, the governments of the four main Eurozone economies under review in this article have acted to try to buffer the shock on economic players, and notably on household purchasing power, via direct subsidies, tax cuts, price regulations and measures to boost nominal incomes
At first glance, higher inflation seems like good news for governments. After all, inflation erodes the real value of debt and lowers the public debt/GDP ratio through a higher nominal GDP. However, the impact of inflation on public finances depends on whether higher inflation was anticipated by financial markets and on its expected persistence. Both factors would influence the borrowing cost and hence the dynamics of the debt ratio through the difference between this cost and nominal GDP growth. Public finances should benefit from having a central bank that is credible in its ability to keep inflation expectations well anchored and is not afraid of tightening policy when inflation has moved well above target
Inflation is continuing to spread among the various components of the consumer price index (CPI). The energy component fell slightly in April (-2.5% m/m) after the government introduced a fuel rebate, but that decline was more than offset by faster inflation in other components of the CPI. Food prices in particular rose by 1.4% m/m in April, the sharpest increase for 20 years, beating figures seen in previous waves of food price inflation in 2007-08 and 2011. Food was the main contributor (0.2 points) to monthly inflation in April (0.4% m/m).
Latest inflation figures give the Spanish government a little respite. Having approached 10% in March (9.8%), consumer price inflation fell to 8.4% in April. Measures taken by the authorities to stem the rise in energy prices – mainly through subsidies and tax cuts – had a beneficial effect. However, food price inflation rose to 10.1% y/y in April. In addition, its contribution to overall inflation (1.98 percentage points) is now roughly the same as other energy-related components of expenditure, i.e., transport (1.98 points) and electricity, gas and other fuels (2.30 points).
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.
