Is Inflation Going to Increase in the Eurozone?

According to the European Central Bank (ECB), consumer price inflation will continue to rise in August after reaching a record high of 2.2 percent in July, up from 1.9 percent the previous month and the highest level since 2018.

Preliminary estimates from Reuters suggest that euro-area inflation will hit 2.8% in August, its highest level since 2012. Analyst Fabio Balboni’s stock price plummeted significantly, especially in August of last year.

According to him, “a genuine pocket of inflationary pressure” has formed in the eurozone, notably within tourism, but that firms are still hampered by decreased capacity, which he attributed to companies reopening.

It is predicted by Balboni that eurozone inflation would reach 3.3 percent in November, and then decline in 2022. On the other hand, rate cutbacks, energy cost recovery, and supply chain interruptions have a negative influence on input costs.

Many economists believe that high inflation will not lead to monetary tightening for the foreseeable future. They stated the ECB is keeping its accommodating monetary policy despite the recent inflation spike.

It is expected that supply would catch up with demand and decrease its underlying impacts over time, according to Oxford Economics analyst Mateusz Urban in a “temporary evaluation of the ECB’s recent acceleration of headline inflation”. As a result of the unsolved supply bottleneck and a quick labor market rebound, he added, “underlying pricing pressures in the eurozone remain muted.”

Pandemics and Inflation

Since the beginning of the year, the global inflation rate has risen significantly. Inflation is increasing across the board, although at varying rates in different nations. The rise in headline inflation, according to the research team of ForexBrokersList website, is the result of two factors that work together. In the first place, energy prices have skyrocketed. Brent crude oil’s price has risen by about 80 percent in the past year. The majority of the increase in commodity prices is attributable to a year ago’s very low pricing.

When comparing costs today with prices two years earlier, when the epidemic hit, it’s easy to see why. Energy price inflation was essentially flat throughout this time period across the eurozone as a whole. This means that during the previous two years, the cost of electricity for families has remained the same.

Global headline inflation has also been boosted by a sharp rise in inflation rates over a larger consumer basket.

Since then, the growth has been more evenly distributed around the globe. When it comes to core inflation in the Eurozone, which eliminates volatile items such as food and energy, there has been no upward pressure thus far.

This is because it takes time for the slack in the economy to be taken up, and for pricing pressures in the economy to grow. According to estimates between this year and 2022, the OECD’s production deficit will be about -3%.

As a result of two pandemic-related phenomena, global core inflation has risen to record levels in recent months.

First, last year’s unprecedented decline in service sector activity slowed down the pricing pressure in contact-intensive industries. 

A lack of capacity utilization in the Eurozone is a result of social distancing measures that have not yet been lifted.

A little over a year, the global and eurozone manufacturing sectors have been increasing rapidly, indicating the shift in demand from services to products. Manufacturers’ production is increasing at an unprecedented rate in the eurozone according to the purchasing managers’ index, a solid indicator of actual growth.

As a result of the high demand, chemical, wood, plastic, metal, and semiconductor chip shortages are on the rise, exacerbated by transportation interruptions. After the epidemic, the costs of numerous basic commodities have skyrocketed, even with the recent ease in price pressures.

A result of this is that the input prices and delivery times of euro area businesses have risen to record highs. 

The rate of inflation in the Eurozone is presently four times higher than it was in the five years before the epidemic, according to Eurostat. In absolute terms, however, especially in worldwide comparison, it remains low at just 1.2 percent each year.

Inflation Outlook for Eurozone

As long as the supply-side shock is short-lived and transitory, it has no impact on the conduct of monetary policy. It’s difficult for central banks to reduce short-term cost pressures because of large delays in the transmission of monetary policy.

Money policy is more concerned with how inflation will develop over the medium term, which will rely, among other things, on the projected durability of existing inflation drivers.

This is due to the fact that the base effects of both energy price inflation and prior policy initiatives, such as Germany’s value-added tax decrease from last year, are disappearing.

A scarcity of intermediate products and shipping delays are also likely to diminish as the supply catches up with demand in time.

Or in other words: Inflation will converge back to levels predicted by traditional Phillips curves, which depict inflation as largely driven by domestic demand and inflation expectations. The latter determines whether temporary shocks become embedded in the inflation process over the long term.

It is predicted by these models that when temporary supply-side shocks dissipate, the euro area’s underlying price pressure will eventually regain its vigor. Inflation expectations for 2022 and 2023 have been revised upward, putting them slightly above the average estimate from a range of Phillips curves.

Core inflation is expected to reach 1.4 percent in 2023, which is higher than the 1.2 percent it averaged after the 2008 financial crisis. This reflects the expectation that slack would progressively be reabsorbed during the projected horizon, putting upward pressure on wage growth in the process.

Since oil prices are expected to rise in the future, a moderate headline inflation prediction in the Eurozone has been influenced by projections about future oil price rises.