Policymaker rhetoric damped enthusiasm around a sharp drop in European inflation on Thursday.
“There is no clear evidence that underlying inflation has peaked,” Christine Lagarde said, speaking in Hanover. “We need to continue our hiking cycle until we are sufficiently confident that inflation is on track to return to our target in a timely manner.”
Just prior to Lagarde’s remarks, preliminary data for May showed headline inflation receded to 6.1%, the slowest YoY pace since Russia invaded Ukraine.
Core price growth likewise slipped, but remained near record highs at 5.3%. That was softer than the 5.5% economists expected.
I wouldn’t go so far as to write the “favorable” (the scare quotes are there to denote that such assessments are highly relative in the pandemic/war era) prints off as meaningless, but energy prices are obviously a factor. The energy measure fell on both a YoY and MoM basis.
Gas futures have collapsed. The benchmark is lower by two-thirds in 2023, and now sits at 2021 levels. Futures are on track for a ninth straight weekly decline. Prices are around €25 per megawatt hour. They were nearly €350 in the immediate aftermath of Russia’s decision to invade Ukraine and also in August, when a harrowing upward spiral raised fears of an existential energy crunch during the winter months.
The barely-veiled glee at Europe’s predicament expressed late last summer across some “fringe” web portals fond of trafficking in anti-Western, economic counter-narrative gave way to crickets on this issue in 2023. Europe’s reserves are nearly 20pp higher than the half-decade average for this time of year thanks to a mild winter and efforts to curb demand.
That’s the good news. The bad news is that inflation eventually found its way into services and wage-setting, where it can be difficult, if not impossible, to dislodge. Services inflation ran at 5% in May, Thursday’s data showed. That was cooler than April and March, but 1.5pp higher than May of last year, underscoring inflation’s migratory tendencies.
Thursday’s report came on the heels of data which showed inflation in Germany moderated sharply last month in what ING suggested could be the beginning of “a gradually broadening disinflationary process.”
To be sure, the monetary policy transmission channel appears to be working better than critics (like me) would’ve predicted. The ECB’s Q1 lending survey showed credit conditions remained tight and loan demand plunged amid higher rates. Broad money growth in Europe was the slowest since 2014 in March.
Still, even a cursory glance at the CPI release betrayed the severity of the problem. Although the YoY pace of price growth cooled for every major aggregate and line item, the numbers are still very high — 9.6% for unprocessed food, 5.8% for non-energy industrial goods and so on.
“Beyond statistical noise, the German and European inflation outlook is highly affected by two opposing drivers, ING’s Carsten Brzeski wrote. “Lower-than-expected energy prices due to the warm winter weather are likely to push down headline inflation faster than recent forecasts suggest [but] recent wage settlements and still decent pipeline pressure in services are likely to keep core inflation high,” he said.
In addition to Lagarde, both Klaas Knot and Olli Rehn weighed in Thursday. Speaking in Brussels, Knot said markets may have to be disabused of the notion the ECB will cut rates in 2024. In Tokyo, Rehn said the ECB can’t consider easing until the bank sees “a steady and sustained decline in underlying inflation.”
