Bbefore the In the midst of the pandemic, the prospect of 10% annual inflation in the eurozone would have seemed like a horror story. There was good news in November. In the previous month, inflation was still at 10.6%. A similar surprise came from America. As inflation falls, so does the expected pace of rate hikes. On December 14-15, the Federal Reserve, the European Central Bank and the Bank of England are all likely to hike rates by half a percentage point – a slowdown from the three-quarter-point hikes that have prevailed recently.
Global inflation has fallen mainly because energy prices have eased since the summer and because supply chains, long stuck together by the pandemic, are functioning more smoothly. However, inflation is still a long way off central banks’ 2% targets. There are three reasons to think rate-setters will struggle to meet their goals anytime soon.
The first is a persistent labor shortage. While news on prices has been good, the latest payroll data is worrying. In America, average hourly wages have shown encouraging signs of slowing since August. But updated numbers released on Dec. 2 turned the picture on its head, showing annualized growth of 5.1% over the past three months, roughly in line with other surveys. Since the data was released, stock markets in America have fallen on expectations of continued interest rate hikes. In Britain, wages are rising at a similar rate; a wave of strikes can lead to even larger increases. Eurozone job markets, while not as sizzling, are hot enough to have policymakers worried that energy inflation could hurt the rest of the economy as workers haggle for higher wages to offset the rising cost of living.
The second problem is fiscal policy. It would help central banks cool labor markets if governments reduced budget deficits. But America’s recent anti-inflation law is only minimally affecting government borrowing, and the Biden administration is attempting to forgive swathes of student debt. Europe is squandering on energy subsidies despite US government warnings IMF and others that it is unwise to stimulate economies that lack idle manufacturing capacity — a mistake America made in 2021 when President Joe Biden’s “American bailout plan” overheated the economy. If the EU maintains its measures in 2023, the cost minus the taxes levied to fund the handouts will reach almost 2% GDP (see grafic). Overall, Britain’s much-touted belt will tighten, thanks to its costly energy price cap, not before 2025.
Almost two thirds of the EUEnergy spending comes from controlling prices for everyone, which is expensive and discourages energy saving. Only a fifth comes in the form of targeted redistribution to those in need, as recommended by the likes IMF. Even Germany, which has capped prices at just 80% of a household’s previous consumption, is still borrowing to fund the scheme, meaning it will provide an economic stimulus.
The final danger is that energy inflation returns in 2023. This year, European economies have benefited from weak competition for scarce supplies of global liquefied natural gas (LNG), in part because China’s economy has been hampered by its zero-Covid policy. But China has started to relax its pandemic controls. When its economy reopens and recovers, LNG prices could rise in 2023. Central bankers’ fight against inflation has reached a turning point. But it will not be won for a long time. ■
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