4 min read.Updated: 28 Nov 2021, 05:57 PM ISTPaul Hannon, The Wall Street Journal
Economists see inflation declining next year, as central bank prepares plan for rates
Consumer-price inflation in the eurozone likely hit a record high in November, but many economists think that might mark a peak for now, and therefore don’t expect the European Central Bank to raise its key interest rate next year.
As in the U.S., consumer prices in the eurozone have risen faster over recent months than most economists and policy makers had expected. The data have raised questions for investors, businesses and households about the credibility of central bank assertions that this period of high inflation is likely to prove transitory.
Many private economists forecast that inflation in the eurozone will decline significantly at the start of the year, echoing the ECB’s view that the period of rapid price rises will be short-lived. The firms sharing this view include UBS, Morgan Stanley, BNP Paribas and Oxford Economics.
“There is a lot of pressure on central banks," said Reinhard Cluse, an economist at UBS. “But the ECB will stick to the transitory narrative, which we believe is correct."
However, with inflation set to remain well above the ECB’s target for the first six months of 2022, a self-reinforcing round of wage rises and further price increases remains a possibility, while the ultimate severity and duration of supply-chain problems and their effect on prices is uncertain.
The European Union’s statistics agency is expected to estimate Tuesday that prices were between 4.3% and 4.5% higher in November than a year earlier.
That would mark the fastest annual rise in prices since records began in 1997. During those 24 years, the inflation rate has only exceeded 4% in two months, the first of those being July 2008, and the second October of this year.
The ECB is scheduled to set out in December its expectations for 2022. But policy makers are unlikely to announce any moves to counter the inflation surge, other than confirming that a bond-buying program launched to soften the economic impact of the pandemic will end in March.
They will likely repeat their view that the eurozone’s inflation rate will fall through 2022 and will be back below their 2% target in 2023. That decline is set to start with a large drop in the pace of price rises in January.
One reason lies in Germany’s efforts to support its economy during the early months of the pandemic. In July 2020, the government of the eurozone’s largest member cut its value-added tax rates for six months. That meant consumer prices from July 2021 onward were being compared with artificially low prices from a year earlier, exaggerating inflationary pressures. From January 2022, that will no longer be the case, since the tax rates reverted back to their pre-pandemic levels at the start of 2021.
But after the January 2022 drop, the decline in inflation is likely to be less pronounced in subsequent months, and largely driven by weaker energy prices. Prices of natural gas—which set the tone for Europe’s wider energy markets—have soared to record highs over recent months, but futures markets suggest they should fall back significantly in 2022.
Economists at Morgan Stanley estimate that 2.2 percentage points of the 4.3% inflation rate they expect to see as November’s peak will have come from energy. That is a larger share than in the U.S., which underlines differences in the inflation surge. While prices of manufactured goods and services have been rising at a faster pace in the eurozone, they haven’t recorded as strong a surge as in the U.S.
According to a measure compiled by the Organization for Economic Cooperation and Development that excludes energy and food prices, so-called core inflation in the U.S. was more than twice the eurozone rate in October.
One reason for that might be that pandemic-driven government financial assistance to households was larger in the U.S. than in the eurozone, Morgan Stanley economists wrote in a note to clients.
More fundamental forces are likely also at play. Over the decade leading into the pandemic, the eurozone economy grew more slowly than that of the U.S., and inflation was weaker. The eurozone has a more rapidly aging population, which economists believe weakens inflationary pressures.
By late 2022, some economists see eurozone inflation hovering once again around 1%, to the ECB’s frustration. While high rates of inflation are seen by most policy makers as a temporary challenge, they have deeper worries about the risk that the eurozone might slide into the kind of low-inflation trap that Japan has been unable to escape.
Some economists see the current period of high eurozone inflation giving a lasting boost to the ECB’s efforts to keep price rises at around 2%, something it has failed to do for much of the past decade.
Luigi Speranza, chief economist at BNP Paribas, is among those who think that by tolerating the inflation surge without raising rates, the ECB can send a signal that it is determined to see prices rise at its target rate over the medium term.
“Price pressures are set to build up in a more sustainable way," he said. “This is a turning point."