Things are starting to get interesting again.
On Tuesday, Eurostat said headline inflation ran 3.3% in Europe last month, the quickest annual pace since September of 2023.
Although not unexpected (the preliminary readout for August matched estimates), confirmation that overall price growth’s running the fastest in nearly three years likely sealed the deal on another rate hike from the ECB, which’ll meet in Berlin next week.
August marked the third month in five that headline price growth exceeded the ECB’s target by at least a full percentage point.
The good news is that core inflation actually receded in August, according to Tuesday data, as did services inflation. But the Governing Council’s pretty adamant about not letting an oil-driven upturn in overall price growth get away from them, scarred as they are by the 2022 energy shock.
Recall that inflation in Europe peaked at a harrowing 10.6% in October of 2022. While unwelcome anywhere, double-digit inflation, whatever its cause, is a total non-starter in the developed market context.
As the figure above shows, the real policy rate in Europe’s been meaningfully negative since April. The ECB hiked in June and telegraphed little patience for another inflation overshoot at July’s meeting.
The trouble here for central banks is that while necessary to anchor long-end bond yields, raising rates is inherently bond bearish. What to do?
It’s absolutely the case that a hawkish reaction function can cap yields further out the curve, both by curbing inflation expectations and, in more extreme cases, curbing aggregate demand through actual policy tightening. But short rate expectations are obviously a component of long-end yields.
The figure above, from BofA, gives you a sense of how the war’s impacted policymaking. There were more hikes than cuts over the past three months globally, and BofA expects that trend to continue.
Earlier this week, while holding court in the Oval Office, Donald Trump suggested Kevin Warsh zig while everyone else zags.
“He’ll do what he has to do,” Trump said of Warsh, adding that in his opinion, the US “should pay the lowest interest rates anywhere in the world, by far.”
Much as it pains me to agree with him — and as unequivocally dangerous as this administration’s legal crusade against Jerome Powell and Lisa Cook surely is — Trump’s not necessarily wrong.
There’s something backwards about a situation where countries that depend on America to underwrite their sovereignty pay less to borrow than the US. Do note: Not all of those countries issue hard currency in a strict sense, and the ones who do are in no better shape fiscally than America.
In any event, and coming full circle, things are getting interesting again. As they tend to do when the price of money starts to rise.
