The European Central Bank now has to deal with double-digit inflation, announced at 10% on 30 September. This is the result of the consecutive shocks on the commodity markets, especially on the energy markets, since the Russian invasion of Ukraine on 24 February. It should be noted that energy inflation was 40.8% in September, compared to 38.6% in August. Coupled with congestion in supply chains due to health restrictions in Asia and the war in Ukraine, the energy crisis is causing a supply shock. The main cause of the inflation rate, which is not only persistent, but also galloping.
However, double-digit inflation is not only due to geopolitical reasons. Long before the various supply shocks materialised over the past seven months, a demand shock was already underway. This supply shock was driven by the wage increases negotiated towards the end of 2021. By the first quarter of 2022, the euro area negotiated wage rate indicator had even exceeded its pre-pandemic level.
An analysis of core inflation--an index of the inflation rate that represents the long-term trend in inflation and is calculated by excluding, among other things, the volatility of energy prices--already showed a significant increase since the beginning of 2021. The ECB has calculated that non-energy inflation has risen from just over 0% at the end of 2020 to over 4% in 2022.
Production has seized up
In general, production has not been able to keep up with the suddenly high demand during the highly rapid recovery of economic activity--up to 5.1% in 2021 in the euro area--as a result of multiple shutdowns of production facilities.
Even if the geopolitical causes of the supply shock were to subside soon, the level of non-energy inflation would not fall so easily. On 8 September, the ECB noted: “Non-energy inflation is expected to remain at unprecedentedly high levels until mid-2023”, but to decelerate gradually as the economy reopens.
Finally, the energy crisis has added to the demand shock and the surge in underlying inflation. This is why even a drop in purchasing power expected from ECB rate hikes may not be enough to alleviate all inflationary pressures. Indeed, a drop in demand seems quite ridiculous in the face of the current energy crisis, which is likely to wipe out part of the supply and demand simultaneously.
This article was published for the Paperjam + Delano Finance newsletter, the weekly source for financial news in Luxembourg. Subscribe using this link. Read the original French version of this editorial on the Paperjam site.