EMU HICP: Stuck in the Middle with You?

Inflation in the European Monetary Union picked up in July, rising by 0.4% compared with a 0.1% rise in June. Progressive inflation rates calculated over 12 months, six months and three months don't show a clear pattern, but the tendency is uncomfortable. The 12-month pace of 2.5% is exceeded by both over three months and six months. Over six months the pace jumps to 2.8%; over three months it backs down but by just a tick to 2.7%. To the extent that represents a pattern is not a good one.

The four largest economies in the Monetary Union each shows acceleration for July compared to June. Italian inflation jumped by 0.9% month-to-month in July after rising 0.2% in June. German inflation rose by 0.5% after rising 0.3% in June. In France, prices rose by 0.4% after rising 0.1% in June. Spain logged an increase of 0.2% after having prices fall 0.1% in June. These monthly numbers show a clear tendency toward acceleration.

Headline trends- Over three months the large country trends are mixed. Germany and Italy show accelerations in their respective HICPs over three months compared to six months. And both also show acceleration over six months compared to 12 months. But France and Spain each show weaker inflation over three months than over six months; Spain shows inflation steadily cooling from 12-months to 6-months to 3-months. Only Spain shows 3-month inflation below 12-month inflation. The 12-month pace of inflation is higher in July than in June for three of four large countries, again with Spain as the exception. Despite this inflation slowdown, Spain has also been a leading growth economy in the second quarter. However, below we will see that Spain’s core inflation trend tells a different story.

Core trends- Core (or ex-energy inflation) shows acceleration in Germany, Italy, and Spain. Despite Spain’s encouraging headline inflation and inflation progression, the core tells a different story. Spanish and Italian core inflation rates show steady acceleration from 12-months to 6-months to 3-months. Germany’s three-month pace exceeds its six-month pace and its 12-month pace; there is a slight one-tick reduction in the pace from 12-months to 6-months. On balance, core inflation is not encouraging. Core inflation rates are well above 2% over 12 months, ranging from 2.5% to 2.8%. The 3-month paces range from 3.1% to 4.3%.

Central bankers- Central bankers have been poised to announce rate cuts and the ECB has already started the process. But inflation developments do not seem to be encouraging for that process to continue. Meanwhile, the Federal Reserve in the U.S. continues to talk of inflation behaving and looking more manageable. In the U.S., there is some motivation for a policy shift from a steady rise in the rate of unemployment. Of course, cutting against this grain, is the BOJ that has been on a different path and just today announced a long-awaited rate hike.

Trend dilemma- The chart is clear that inflation in the U.S. and in EMU has dropped then has flattened out to a pace above target in both the U.S. and the EMU. The U.K. faces similar resistant trends. Central banks are eager to try to put growth back in gear. Recent EMU growth has been lackluster; growth in the U.S. has been much better, but the U.S. employment-creating machine shows signs of aging. Policy makers have a motivation to cut rates, but they also have a lengthening legacy of being over target. Something has shifted in their central bank reaction functions and priority schemes to create this difference. Inflation is no longer the only objective in town, and it may no longer be the main one. Alternatively, central bankers may have simply effectively loosened their targets by reducing their vigilance and adherence rather than shifting the actual target. They do this by excusing short-term overshoots but claiming 2% is still the long-term target. There has been a lot of criticism of central bankers targeting 2%. And while central banks continue to voice their devotion to 2%, their actions suggest something else.