EMU PPI Shows Flashes of Heat in December

In the wake of a meeting by the European Central Bank and release preliminary GDP results for the Monetary Union in 2024-Q4 as well as for key countries, we're now getting some early inflation data that puts policy in conflict with economic data. At the meeting, ECB president Christine Lagarde made it clear that the central bank had cut rates and that it sees inflation on a path to come down to target. In the wake of that meeting, an announcement of GDP data for the Monetary Union showed extreme weakness for the union in the fourth quarter with GDP growth essentially at a standstill and with growth slowing quarter-to-quarter in nearly all of the countries that reported GDP on an early basis. However, the economic data for inflation don't seem to be cooperating.

Is a bird in the hand really worth two in the bush? Economists say No… There is an old expression that economists seem to turn on its head that expression is this: “a bird in the hand is worth two in the bush.” Translating this into economic data, we have actual economic data, and we also have forecasts for the future. Economists always want to make policy not based on the data in hand but on the forecast for the future (those ‘in the bush’). However, like the hunter who thinks that there are still two in the bush, the ECB, thinking it they can rely on forecasts of inflation may cause it to come home with nothing to eat. However, economic theory is pretty clear that monetary policy works with a lag and therefore it is beneficial to look at forecasts for inflation to make policy today. But that only works if the economist can forecast well, and we know that we can't forecast GDP well or inflation that well and that poses a dilemma for policy.

Despite the ECB forecast that inflation is coming to path, this is an uncomfortable PPI report released in December. It has the core PPI up by only 0.3% compared to a 0.1% rise in November. The inflation progression moves from 2.8% year-over-year to 2.4% at an annual rate over six months, to 2.7% at an annual rate over three months. That's a relatively mild and not entirely clear pattern toward acceleration. On the month, inflation has broken lower with 10 early reporting European countries all showing an inflation in December with a smaller gain month-to-month than what it showed in November. However, encouraging that might be, November brought sizable gains for a number of these countries where 79% of them saw inflation accelerating in November; a deceleration in December isn't quite as impressive, accounting for that. Moreover, if we look at countries reporting data over 12 months, six months and three months, we see that over 12 months compared to a year-ago inflation is accelerating in all of these countries. For six months compared to 12-months, inflation is accelerating in about 56% of them. For 3-months compared to 6-months, it's accelerating in all of them. Over three months, six of these ten reporting countries are showing annualized PPI inflation in double digits! This does not seem to be something we should take lightly even though the headline increase for the period for the euro area is only 2.7% annualized.

HICP inflation for January is mixed In addition, HICP data for January has been released on a preliminary basis for three of the larger the monetary union economies: Germany, France, and Spain. In each case, inflation is accelerating over three months to a higher pace than over six months. For Germany, the 3-month pace is 4.4%, for France it's 2.4%, and for Spain it's 7.1%. These accelerations have brought the year-over-year pace for Germany to 2.8%, for France to a still moderate 1.8%, and for Spain to 2.9%. Germany’s ex-energy inflation is still relatively flat at 2.4%, over three months lower than its 2.8% 12-month pace. For Spain corn inflation at 2.1% over 3-months is moderate and lower than its 12-month pace of 2.4%.

Core inflation is solid, as far as it goes The inflation picture in the core available for two countries is relatively benign, although the inflation rate for the headline for the three early reporting countries is not reassuring. In addition to that, we have PPI data that are showing some very intense pressure on a more widespread basis than we should be comfortable with.

ECB sees the right path ahead...is it right? So, the ECB has recently met and reaffirmed that it thinks inflation is on the right path and so this is going to be something to watch. There's still a great deal of weakness in the euro area; if the weakness is going to remain that severe, it's highly likely that inflation will find it hard to get a toehold. However, at the same time, the recently reported unemployment statistics revealed only the smallest bump up of unemployment at the end of the fourth quarter. Unemployment in the EMU is only one-tenth of one percent above its all-time low. Across the various members of the Monetary Union, unemployment remains at extremely low levels. That raises the question of whether inflation pressures are building or not since the tight labor market can be a problem for inflation even if growth is weak.

Summing up We are clearly looking at atypical macroeconomic developments in the wake of COVID and the presence of a hot shooting war on Europe's doorstep. All this comes after a period in which inflation has flared sharply, after a long period of inflation being tepid. Because there has been a recent flare up in inflation, central banks should be wary that transactors could again become quickly sensitized to the presence of inflation and regain expectations for rising prices more easily than they did in the pre-COVID period. It seems to be a time that central bankers should be vigilant about inflation and less confident that they know what the future will bring and making policy based upon forecasts that we know to be tenuous.