EMU Inflation: Moving Sideways But Still Overshooting

Inflation in the European Monetary Union rose sharply in November, logging a 3.1% annual rate increases on a month-to-month basis. This represents an acceleration from a 1.9% annual rate month-to-month change in October and follows a 2.5% annual rate decline month-to-month in September. The core HICP is available only through October, a month when it expanded month-to-month at a 3.2% annual rate, after falling month-to-month in September at a 0.3% annual rate. The month-to-month inflation results and trends are not particularly encouraging.

Monthly trends mix good with bad news- The table below presents annualized rates of change on all horizons to permit easy comparisons of one tenor with the next. In November, the median annualized inflation rate for this group of 10 countries was an annual rate gain of 1.9%. That represented an acceleration from 0.9% in October; October represented an acceleration from -3.2% at an annual rate in September. All the median results are below the 2% target set by the ECB – and that is good news- but the trend in the monthly data remains adverse. But, of course, we also have the overall EMU results that show inflation just under ‘target’ in October at 1.9% but back to excessive in November at 3.1%.

Monthly sequences by country disappoint- Looking at the monthly sequence of inflation numbers, Belgium shows monthly inflation trends from September to October to November accelerating steadily, as does Luxembourg, the Netherlands, and Spain. There are no countries in this sample with inflation rates showing step-wise deceleration from September to October to November except Greece.

Broader sequential inflation patterns However, sequential inflation, viewed broadly from 12-months, to six-months, to three-months, shows deceleration in the headline with 12-month inflation at 2.3%, the six-month pace falling to 1.7%, annualized and the three-month pace down to 0.8% at an annual rate. The core CPI that is calculated by lagging data by one-month shows relative stability over 12 months and six months, amid only a minor 6-month backtracking, and then a drop off in the three-month annualized inflation rate to 2.1% - essentially on-target.

Broad cross-countries annualized inflation rates over 12 month, six months, and three months, show a steady decline in the pace of inflation for Belgium, France, Germany, Italy, Luxembourg, the Netherlands, and Ireland. Only Portugal, Spain, and Greece fail to show decelerating patterns; among those countries, there's no discernible acceleration or deceleration tendencies.

Good news- tempered- The appearance of broad sequential deceleration is good news; however, it does buck the trend of significant accelerating tendencies for inflation over the last three months and that raises some question of where the trend is really headed. Over three months compared to six months inflation decelerates 70% of the categories; over six months compared to 12 months inflation decelerates 90% of the categories; inflation over 12 months compared to what it did 12 months ago shows deceleration in only 40% of the categories. The median inflation rate for the monetary union shows deceleration falling from a 2.4% annual rate over 12 months, to 1% pace over six months, to a 0.2% annual rate over three months inflation progress. But the headline is not as compliant as that. At the same time, good trends are present, and good news is elusive depending on the timeline and metric we wish to focus on.

Mostly excessive inflation over 12 months- With an ECB target inflation rate of 2%, the 12-month change in the HICP is excessive at 2.3%. The core which lags a month is excessive but the pace at 2.8% year-on-year. Inflation, measure year-on-year, is excessive in Belgium, Germany, the Netherlands, Portugal, Spain, and Greece. Inflation is compliant or below the target set by the ECB in France, Italy, Luxembourg, and then Ireland. Of course, these are only references, only the official EMU-wide inflation rate matters.

Policy conundrum- The chart at the top of this report provides a good depiction of what inflation is doing throughout the community. The answer is that inflation came from a period of excessive results with broad based overshooting and settled down rapidly to register inflation growth rates much closer to target and in some cases below target. However, the decline in inflation has run out of steam- and lost most of its downward momentum a year ago. Inflation has, since the period of the greatest deceleration, become ‘stuck’ at a pace above what the ECB has targeted and that creates a dilemma for policy in the future.

What lies ahead- Inflation progress has come a long way, but the inflation rates are currently not compliant and after an extended period of inflation being excessive it's important for the central bank to show that it takes its target seriously and is prepared to hit it. The overall HICP result that shows inflation over 12 months at 2.3%; it's not a terribly excessive overshoot even after the past period of excessive inflation. But the core pace at 2.8% is far too high - given that same history - for the ECB to think that it can be ignored or swept under the rug or is ‘close enough to target.’ It certainly isn't. Yet, growth in the economic union continues to be spotty and the only thing that keeps that from pushing policy clearly to look for more rate reductions is the fact that the labor market has remained quite resilient and the unemployment rate in the euro area remains at its historic low, despite slowing in other economic data. This is an uneven standoff among the important economic variables that will probably be tipped one way or the other in coming months. What remains to be seen is whether the unemployment rate is going to begin to move up more consistently or whether the inflation rate is going to take on a new clearer trend that will either permit the ECB to continue cutting rates or stay its hand more seriously.