Disastrous Inflation Overshadows Stale European Growth Surprise

Inflation in Europe rose more than expected in July, preliminary data out Friday showed.

It was an unwelcome development for the ECB — the latest inauspicious turn in a never-ending series of unfortunate events. The sheer quantum of bad news foisted upon Europeans in 2022 is lamentable.

Headline inflation probably rose a sweltering 8.9% this month (figure below), the flash estimate from Eurostat showed. That was more than expected and marked another record high.

Core was 4%, also a record and also higher than economists saw. Needless to say, the pace of energy price growth remained mind-bogglingly elevated at 39.7% YoY. That figure was 42% in June and 39% in May.

Food inflation is near double-digits. The 12-month rates for non-energy industrial goods, services and food, alcohol & tobacco, all accelerated versus June. Monthly rates for both services and processed food, alcohol & tobacco exceeded 1%.

The data came a week after the ECB opted for a 50bps rate hike at July’s gathering, in what passed for “front-loading.” Technically, the ECB exited negative rates, but by the slimmest of margins — that’s supposed to be funny, although the joke may be too subtle for some readers. There’s nothing subtle about the juxtaposition with inflation, though. It’s outright laughable (figure below).

Christine Lagarde jettisoned forward guidance at this month’s meeting, which could be hawkish or dovish. She explicitly said the old guidance for the September meeting (as communicated in June) is no longer valid following July’s hike. That was generally taken to mean the odds of a 50bps move two months from now are lower, but inflation prints like Friday’s present a challenge.

Policymakers may be compelled to signal to the market that another large increment is still on the table. To be sure, rates will continue to reflect considerable hike premium for the remainder of 2022, but there are already whispers that the ECB’s hiking “cycle” won’t make it beyond September given the likelihood of underwhelming sentiment, activity and growth data going forward.

On that score, a much better-than-expected read on Q2 GDP perhaps helped, to the extent it suggested the economy wasn’t in a recession last quarter, even if more high frequency data suggests it might be now. The bloc’s economy grew 0.7% last quarter from the prior three month period (figure below), separate data out Friday showed. That was more than triple forecasts.

Markets aren’t likely to assign much weight to the print, even if any good news is welcome in a year mostly devoid of it. “The acceleration in economic growth is mainly due to reopening effects and masks underlying weakness due to high inflation and manufacturing problems,” ING’s Bert Colijn said. “Expect the economy to contract once the COVID-19 rebound effects are played out.”

Germany’s economy flatlined in the second quarter, the country’s statistics office said Friday. Household and government spending helped offset a drag from trade in the bloc’s largest economy, which is bedeviled by the constant threat of an energy crisis. Berlin reached a deal to rescue Uniper last week, as the energy giant became the first major corporate casualty of Vladimir Putin’s war in Ukraine. The French, Italian and Spanish economies grew by 0.5%, 1% and 1.1%, respectively, last quarter.

“We still expect the eurozone economy to enter a shallow recession in H2 2022-H1 2023,” Rabobank senior economist Maartje Wijffelaars wrote, adding that “the risks of a severe contraction due to an energy crisis have increased.” Although the bank expects inflation to “cool a little towards the end of the year,” they flagged “clear” upside risks and expect the ECB to hike rates by 50bps in September and October, followed by a 25bps hike in December.

Call me a pessimist, but I’m not sure the bloc’s economy can handle 175bps worth of tightening over four policy meetings without something going wrong somewhere.