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Europeans are in for a costly summer that will test central bankers’ resolve on stimulus as the region’s delayed economic recovery unleashes surging demand.
The question officials face from Frankfurt to Warsaw is whether accelerating inflation will last long enough to alter the longer-term expectations of companies and households. If it does, that could create a self-reinforcing cycle in which higher prices prompt bigger wage demands — despite elevated unemployment — that fuel yet more price increases.
Price pressures could also embolden those central bankers who think policy has been too loose for too long, setting up potentially tense rate-setting meetings later this year. While the official line is that the inflationary spike will be temporary, recent data is fodder for those who worry about the risk that they’re wrong.
“All the cyclical and structural factors add up and point toward a trend reversal,” said Gertrud Traud, chief economist at Helaba in Frankfurt. “Once German inflation hits 3%, the labor unions will ask: ‘And what about the workers?’”
The prospect of faster inflation was evident in a swathe of reports on Tuesday, in which factories said they’re lifting prices at the fastest pace in almost two decades on rising costs and shrinking stockpiles. Euro-area data on Wednesday showed producer prices soared 7.6% in April from a year earlier, the steepest gain since 2008.
That’s feeding through to shoppers. Consumer price growth hit 2% in the euro zone last month — technically above the ECB’s goal — for the first time since 2018. In Poland, it was more than double that. The Bundesbank says German inflation could reach 4% this year.
The 4.8% reading in Poland — which isn’t part of the euro zone — highlights mounting risks. Authorities there are worried 5% would be a tipping point that fuels public inflation expectations, according to people familiar with the thinking of the central bank and government officials.
In Britain, two Bank of England policy makers signaled unease on Tuesday about the prospect that surging house prices, which are rising at the fastest pace in seven years, will fuel inflationary pressures.
What Bloomberg Economics Says…
“Most of the world’s central bankers, including a majority at the Bank of England, remain relaxed about the upcoming surge in inflation. One, though, is worried the ‘inflation genie’ is about to escape.”
-Dan Hanson. For the full report, click here
There’s little sign the global supply squeeze is easing. Asian manufacturers, makers of components for much of the world, slowed activity last month as countries battled with virus flare-ups. Several factories in Thailand have closed temporarily to stem outbreaks, Taiwan has reported record weekly deaths from the virus, and Malaysia has started a two-week national lockdown.
In Europe and elsewhere, increased insolvencies when fiscal support to companies is withdrawn could exacerbate supply concerns.
The Organization for Economic Cooperation and Development said this week that while global price pressures should ease toward the end of the year, there are “upside risks” in the longer term.
Despite the eyewatering jump in Poland, the central bank there reckons that surge in consumer prices is fleeting. It’s so far opting not to follow regional peers including Hungary and the Czech Republic in signaling imminent interest-rate hikes.
Elsewhere, Iceland’s central bank last month became the first in western Europe to tighten monetary policy since the pandemic by raising interest rates, acting to head of a spike in inflation. Norway’s central bank has also signaled that it’s on track to begin tightening.
Read more: A 50-Year Bond From Sweden Is About to Test Inflation Anxiety
At the ECB, whose task is complicated by managing by far the biggest currency area of the region, with diverging growth prospects in different members, officials insist that supply shortages will be overcome, and year-on-year price changes will drop out of the headline figures.
At least one market-based measure indicates that price increases in the euro area will be just over 1.5% in 10 year’s time, still well below target.
Read more: Traders Pricing ECB Rate Hikes Clash With Dim Inflation Outlook
A big driver compared with a year ago is energy costs, because prices plunged when travel was shut down in 2020. The euro zone’s measure of core inflation, which excludes energy, food and tobacco, was a much more muted 0.9%.
“I would be very, very surprised if Europe was getting a broad-based price increase,” said Paul Donovan, chief economist at UBS Global Wealth Management. “Should central banks tighten policy because the price of toilet rolls has suddenly shot up? No, of course not.”
The persistent fear of central bankers though is a “deanchoring” of inflation expectations. That would force them to consider tightening monetary policy — not an easy decision when unemployment is above pre-pandemic levels and massively indebted governments are reliant on low borrowing costs.
The alternative would be to let inflation run hot for a while. That’s arguably valid after the many years in which price growth has been too low, but it risks echoing a 1960s strategy that ended badly a decade later.
“This is not the time to worry about inflation,” Angel Gurria, the outgoing head of the OECD, told Bloomberg Television this week. “Although one should always keep it in the back of our minds.”
(Updates with euro-zone producer prices in fifth paragraph)
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