Euro zone inflation hits new peak, deepening ECB’s dilemma
© Reuters. FILE PHOTO: Shoppers queue in front of a shop one day before Germany goes back to a complete lockdown due to the coronavirus disease (COVID-19) outbreak, in Cologne, Germany, December 15, 2020. REUTERS/Thilo Schmuelgen
By Balazs Koranyi
FRANKFURT (Reuters) -Euro zone inflation surged to 7.5% in March, hitting another record high with months still left before it is set to peak, raising pressure on the European Central Bank to rein in runaway prices even as growth slows sharply.
Consumer price growth in the 19 countries sharing the euro accelerated from 5.9% in February, Eurostat said on Friday, far beyond expectations 6.6%, as war in Ukraine and sanctions on Russia pushed fuel and natural gas prices to record highs.
Although energy was the chief culprit, inflation in food prices, services and durable goods all came in above the ECB’s 2% target, further proof that price growth is increasingly broad and not merely a reflection of expensive oil.
With the ECB having persistently underestimated inflation over the past year, the figure will come as a shock to policymakers, some of whom are already calling for tighter policy to avoid high price growth becoming entrenched.
“The inflation data speak for themselves,” Joachim Nagel, president of the German Bundesbank, said on Friday. “Monetary policy should not pass up the opportunity for timely countermeasures.”
The central bank governors of Austria and the Netherlands have already called for rate hikes this year, worried that rapid price growth is becoming broad-based, an argument supported by underlying data from Friday’s release.
Inflation excluding volatile food and fuel prices, closely watched by the ECB, picked up to 3.2% from 2.9% while a narrower measure that also excludes alcohol and tobacco products jumped to 3.0% from 2.7%.
Any cut in Russian gas supplies would also quickly feed through to customers, boosting prices even as governments are putting in place subsidy measures to offset some of the cost.
INFLATION SOARS, GROWTH STAGNATES
All this leaves the ECB with a difficult policy dilemma.
Its main task is to get inflation to 2% but tightening policy now would risk crashing an economy that is already reeling from the fallout of the war in its neighbour and the lingering impact of the COVID-19 pandemic.
The ECB estimates that growth in the first quarter was positive, but barely, while second-quarter growth will be near-zero, as high energy prices dent consumption and hurt corporate investment.
That would suggest the bloc is near a state of stagflation, where rapid inflation is coupled with stagnating growth.
High energy prices are traditionally a drag on growth and will thus actually weigh on inflation once the immediate spike passes, raising the risk that price growth will later fall back below target.
But the ECB can hardly ignore high inflation, especially since it says the peak is still three to four months away.
The euro zone’s labour market is the tightest it has been in decades so wage inflation, a precondition of durable consumer inflation, is already in the pipeline. And ECB inaction would also boost inflation expectations, likely making price growth more permanent.
“Looking ahead, all of the latest survey evidence suggests that price pressures remain extremely strong, so there is a good chance that core inflation will keep rising,” Jack Allen-Reynolds at Capital Economics said.
“We think that the ECB will soon conclude that it can’t wait any longer before starting to raise interest rates.”
The ECB has underestimated price growth throughout the past year, so its credibility is on the line.
The likely compromise will be for the bank to tighten monetary policy this year, but by the smallest increments.
Markets are now pricing in 60 basis points of rate hikes by the end of the year but policymakers have been more cautious, with not a single one calling for moves so large.
The risk, however, is that big inflation surprises could force the ECB to tighten more quickly and play catch-up later on.
Euro zone inflation hits another record, raising pressure on ECB