By Balazs Koranyi and William Schomberg
FRANKFURT/LONDON – The Federal Reserve may have given up on its long-standing claim that high inflation is transitory but its central bank peers across the Atlantic Ocean are not quite ready to follow its change of tune.
U.S. Federal Reserve Chair Jerome Powell said on Tuesday it was time to retire the term “transitory” when describing price growth, opening the door to a faster withdrawal of monetary stimulus.
This has investors wondering if the European Central Bank and the Bank of England, which have also used “temporary” and “transitory” in their communication, will be the next shoes to drop.
Not so fast.
It is true that inflation in both the euro zone and Britain is exceptionally high and will take longer to subside than policymakers thought even just a few weeks ago.
But the structural factors driving price growth appear quite different on opposite sides of the Atlantic, backing a divergence in central bank policy.
The 19-country euro zone looks to be the real outlier.
Inflation, at 4.9%, is more than twice the European Central Bank’s 2% target. But it is primarily driven by a German tax hike and high oil prices. Stripped of those, underlying inflation is 2.6% for 2021 and 1.4% over a two-year period.
“The ECB is unlikely to recede from its mantra that inflation is mainly transitory because they’ve clearly communicated that it is currently the result of the well-known trinity of energy prices, base effects and bottlenecks,” said Martin Wolburg, an economist at Generali Insurance Asset Management.
Indeed, core inflation in the United States was 4.1% with labour market stress clearly a factor in price growth.
In contrast, euro zone unemployment is high, labour market slack is ample and wage growth, a precondition of any durable inflation, is anaemic.
The economy is also only just getting back to its pre-pandemic level, two quarters behind the United States, and there is still plenty of spare capacity
“We need to stress that the euro zone is in a different situation to the U.S. in terms of output gap,” an ECB policymaker, who declined to be named, said. “It’s not that I don’t see a risk of inflation landing above 2% but I need to see evidence and we can afford to wait.”
For the euro area, the story will change when companies start raising wages, the ECB has said. This is not yet happening so ECB President Christine Lagarde and chief economist Philip Lane have stuck to their language on “transitory” inflation that will “fade”.
But a change of view in Frankfurt may not be too far off, some think.
A growing number of policymakers feel that the outlook is murky enough not to commit too far into the future.
Analysts are even more outspoken.
“We see greater signs of underlying inflationary pressures building – supportive of our view that the current price shock will prove to be less transitory than the ECB thinks,” Paul Hollingsworth, Chief European Economist, BNP Paribas Markets 360 said.
UK ‘IN BETWEEN‘
The Bank of England also doesn’t appear ready to abandon its stance but some policymakers have expressed discomfort over terminology.
“Perhaps understandably, the word ‘transitory’ has become somewhat notorious of late, as central banks’ characterisation of recent inflation developments has been challenged by repeated overshoots of their inflation projections,” Huw Pill, the BoE’s new chief economist said recently.
Unlikely in the euro zone, UK inflation still has not peaked and could rise to around 5% in the second quarter of 2022 from a 10-year high of 4.2% hit in October.
Indeed, the bank has already said that increases in interest rates are likely in coming months with economists looking for its first move possibly as soon as this month.
“The Bank of England is in between, so they are probably close to the U.S. situation,” Wouter Sturkenboom, chief investment strategist for EMEA and APAC at Northern Trust said.