The inflation rate in the Eurozone rose to fresh record as prices continued to surge. What implications do rising EU and global trade tensions have on this?

The “2021 inflation” is a record high for the Eurozone. The rate of inflation in the Eurozone has been rising for a while, and it was expected to be around 2%.

Eurozone Inflation Rises to Fresh Record, Against Expectations

Eurozone-Inflation-Rises-to-Fresh-Record-Against-Expectations

 

Inflation in the eurozone hit a new high in January, surprising policymakers at the European Central Bank, who have said that they do not intend to hike their main interest rate this year.

ECB officials and most analysts, on the other hand, were certain that the first inflation reading of the year would show a considerable decline, given past adjustments in Germany’s sales tax were no longer included in yearly comparisons.

Instead, according to estimates issued on Wednesday by the European Union’s statistics office, the annual rate of inflation increased to 5.1 percent due to a new jump in energy costs. The Wall Street Journal polled economists last week, and they predicted a drop to 4.3 percent.

The European Central Bank will release its latest policy decisions on Thursday, but nothing is likely to change ahead of its March meeting, when policymakers will debate the implications of updated inflation and growth predictions.

The central bank boosted its inflation projection for this year at its December meeting, but predicted the rate of increase in consumer prices will drop as 2022 approached. It predicted that inflation would fall below its goal in 2023, and that, in that case, it would be unlikely to increase its main interest rate this year.

The Federal Reserve, on the other hand, has suggested that it would likely hike interest rates many times this year, beginning in March.

However, the ECB’s position becomes increasingly difficult to explain to individuals and companies with each higher-than-expected inflation number.

When national inflation numbers from Spain and Germany first hinted at the January inflation surprise on Monday, investors started to have reservations about the ECB’s direction and began to sell eurozone government bonds. For the first time since May 2019, the 10-year German bund yield closed in positive territory, and it did so again on Tuesday. Bond prices currently show that investors anticipate a minor increase in the ECB’s main rate this year, according to economists.

In a note to clients, HSBC economist Fabio Balboni said, “The market is also obviously in the mood for testing the mainstream ECB narrative.”

While the increase in inflation in January was slight, it was nonetheless a significant surprise. That’s because experts had predicted a significant drop in inflation in January as a consequence of so-called “base effects” linked to changes in Germany’s sales taxes.

The government of the eurozone’s biggest member decreased its VAT rates for six months in July 2020. This meant that from July 2021 onwards, consumer prices were being compared to artificially low prices from a year before, inflating recorded inflation. Since the tax rates restored to pre-pandemic levels at the start of 2021, January was the first month in which the base impact was missing from the inflation data.

The absence of that distorting impact was evident in eurozone inflation numbers for January, with the annual rate of inflation for manufactured goods falling to 2.3 percent from 2.9 percent in December. However, surging energy prices negated this, rising 28.6% in the year to January compared to 25.9% in the year to December.

It was the “biggest positive surprise in the history of euro area flash…inflation reports,” according to Frederik Ducrozet, an economist and notable ECB watcher at Pictet Wealth Management.

ECB policymakers, like other central bankers, are hesitant to boost their main interest rate in reaction to supply disruptions over which they have little control. They are concerned, however, that the longer inflation remains above their target, the greater the risk that households and businesses will become accustomed to prices rising faster than the target rate, potentially leading to a self-reinforcing series of higher pay deals and price increases by employers to cover their increased costs.

“Usually they claim they don’t respond to brief price shocks,” said Anna Titareva, an economist at UBS. “This time, the biggest issue is second-round repercussions.” “Their fear is that the longer inflation continues high, the higher the possibility of inflation expectations rising more permanently.”

Workers in the eurozone are seeing a steep drop in their real purchasing power as prices rise, but their negotiating strength seems to be increasing. Wages were only 3% higher than a year ago in the three months leading up to September, according to the ECB, falling behind inflation. According to Eurostat data issued on Tuesday, the eurozone’s unemployment rate dropped to 7% in December, the lowest level since the series started in 1998.

—This essay was co-written by Anna Hirtenstein.

Paul Hannon can be reached at [email protected]

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