No Pivot Yet For The ECB

Soaring prices have emerged as a feature of the pandemic-era recovery and a top risk for investors, consumers, businesses and policymakers. Americans are living with the highest inflation in four decades, the British are witnessing a surge in prices not seen in 30 years, and the Europeans haven’t seen prices rise this quickly since their aggregated recordkeeping began thirty years ago.

While cost pressures have sprung the Federal Reserve and the Bank of England into action, the European Central Bank (ECB) is holding firm. One reason why is that inflation has a very different texture in Europe than it does in other parts of the world.

After struggling for years to reach its inflation target, the eurozone is catching up with America and the U.K. The headline consumer price index for the euro area came in at 5.1% year over year in January, up one-tenth from December 2021.

Nonetheless, the ECB continues to sound less hawkish than its counterparts. Criticism aimed at the central bank for raising interest rates too soon after the 2008 financial crisis may be a reason behind reluctance to tighten policy. But there are several macroeconomic influences that justify the ECB’s stance.

Weekly Economic Commentary - Chart 1

The eurozone harmonized consumer price index (HICP) is a weighted composite of 19 member states. While aggregate eurozone consumer prices have soared, there is a significant divergence at a country level. The core component is still below 2% in three out of four major member states, which diminishes the urgency of tightening monetary policy. Further, the ECB’s forecasts show inflation falling below the 2% target in 2023.

Secondly, there are many more unusual factors affecting eurozone inflation than there are in other regions. Reopening created a huge base increase last spring, which will be receding in the coming months. Supply-chain blockages and uncertainties about the supply of natural gas from Russia have also proved persistent, leading to higher price pressures. Tax changes in member states have also created some volatility in the overall numbers.

The volatile energy component has been the biggest contributor to higher headline inflation in the common currency region. Large base effects caused by higher oil and gas costs have led the energy index upward by a whopping 29% over the last year. By contrast, the other three major constituents, food, non-energy industrial goods and services, account for less than half of the price rise.