Inflation Cools, Flattens, in and across EMU...But Still Runs Strong

Month-to-month inflation moved higher in the EMU and across the EMU region on the month. But that masks the sharp slowing in three-month inflation that remains on the books for the EMU as a whole, for Germany, for France, and for Italy with Spain as the lone ‘large EMU economy’ exception. Even so, all four of the largest EMU economics and the EMU itself show inflation lower over three months (annualized, of course) than over 12 months. Comparing 12-month inflation to the 12-month pace of 12-months ago, inflation is still higher for the EMU, Germany, France, and Italy with Spain as the sole exception. In Spain, 12-month inflation is at 5.8% compared to a pace of 6.2% one year ago. However, comparing the 12-month inflation rate in January to the 12-month pace in December produces a mixed result with inflation lower in the EMU, Germany, and Italy, but higher in France and in Spain.

The Big picture In the big picture, the sequential trends (12-months to 6-months to 3-months) generally show inflation ratcheting lower but not necessarily monotonically. In Italy, inflation accelerates over six months before decelerating sharply over three months. In Spain, inflation decelerates over six months but then pops up over three months but still stays below its 12-month pace, keeping the general notion of deceleration intact.

Core inflation? Only Italy offers up some early core inflation. That result is not as encouraging, showing inflation higher over 12 months than it was a year ago. It shows 12-month inflation higher in January than in December and shows inflation accelerating from 12-months to 6-months to 3-months. Italy’s month-to-month inflation readings for core inflation show stubborn 0.5% increases in November and December capped by a 0.8% gain in January. The Italian core trend is a cautionary benchmark – it may not be generalizable, we don’t know.

What we do know… We know that much of the inflation progress has come from ‘easy comparisons’ with virulent inflation of 12-months ago. And the current progress being made is largely a result of weakening commodity prices and falling oil prices. The core, of course, excludes those items and the core rate is less volatile overall. The Italian core rate shows inflation is stubborn – more stubborn than the tale told by headline inflation.

A difficult period for judgement A number of economists have remarked on how difficult this period has been to handicap economic trends. In the EMU, the composite PMI reading for January moved higher and above 50 for the first time in 7 months. Monthly composite PMI values improved in Germany, France, Italy, and Spain. Spain and Italy saw readings move above the 50 marker for the first time in 5 months for Spain, 7 months for Italy. Across ‘the pond’ the U.S. spins out mixed data in the world’s largest economy with weak confidence readings, weakening consumer spending, but strengthening job growth – the lowest rate of unemployment in 50-years. It is extremely unusual to see the U.S. and EMU showing economic improvement at an advanced stage of a tightening cycle. What is going on?

Answers… The answers to this question are complicated. They lie in the weeds of macroeconomics. Part of the story is that monetary policy works with a lag and while policy has been tightening for year or less, it was previously very expansionary and monetary policy spews its impact with an inconsistent lag. That may mean that we are near the end of the stimulus impact and may be about to get clobbered by a wave of contractionary forces. Money supply boomed and busted in the U.S., the U.K., the EMU, and to a lesser extent in Japan. The U.S. is the best example of this. It had record money growth during the Covid cycle (highest since at least the mid-1960s) and now is experiencing the first contraction in money supply (M2) on that same timeline. Surely this sort of turnabout has impact. Many are looking for inflation to drop more sharply than the Fed is. Some are calling for central banks to pause to create a soft landing. But real interest rates are still largely too low and below inflation. These are conditions - I think it’s fair to say - we have never-before experienced. Beware of wishful forecasting. Now more than ever no one knows what the future holds.