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In the minutes of the last meeting of the European Central Bank (ECB), the talk was of inflation “driven largely by temporary factors that were expected to ease in the course of 2022”, although a “higher for longer” inflation scenario cannot be ruled out, and ultimately a desire to avoid “any premature scaling back of monetary stimulus and asset purchases”. This type of language harks back to reports from the US Federal Reserve (the “Fed”) close to a year ago. The tone of the US central bank has since changed substantially: combating inflation – no longer considered temporary – has become the priority, and the momentum behind scheduled monetary tightening has clearly accelerated. Is the ECB likely to follow its illustrious counterpart, switching to more restrictive policies with a couple of quarters’ delay?
According to its president, Christine Lagarde, nothing is less certain. Questioned last week by the French press, she restated that inflation would stabilise before falling during the year, since it is primarily due to two factors: the rise in energy prices, and bottlenecks in supply chains including congestion at ports. Christine Lagarde also emphasised that in the eurozone we are not yet seeing the strong momentum in wage growth observed in the US, and that the explosion in rent costs across the Atlantic will not be matched in Europe, where much stronger rent control measures are in place.
A well-rounded argument, which nonetheless seems incomplete. The reminder of the differences in the momentum of wage growth in the eurozone and the US is undoubtedly the most relevant of the arguments put forward. Upwards pressure on wages is much lower in the eurozone due to significantly higher minimum wages in Europe, and the opposing approaches taken to the labour market during the COVID-19 crisis – the eurozone focused on furlough schemes to maintain employment, whilst the US took a fire and rehire approach. The prospect of seeing supply chain bottlenecks gradually diminishing also appears realistic, with recent business surveys clearly highlighting this phenomenon.
The housing issue is more delicate. Some rather strict rent control measures in many eurozone countries should prevent the runaway rises seen in the US. On the other hand, it is worth remembering that there is a basic difference between US and eurozone inflation. In the US, housing costs are calculated not just on the basis of rent costs but also on property prices, which represent close to a quarter of the US inflation basket. This element simply does not exist in the European basket, whereas property prices have risen by around 8% over the year. So, considering the cost of housing purely through the prism of well-regulated rents means significantly minimising the impact of inflation in property prices, which is the major driver of inflation in the US. Finally, Christine Lagarde’s apparent confidence that commodity prices will ease could prove excessive. Given the deficit in hydrocarbon production capacities, whilst demand has not yet fully recovered, and given the eurozone’s dependence on fossil fuel energy after a decade of anti-nuclear policies, the cost of energy could continue to rise in the coming months.
Thus, although it seems highly unlikely that European inflation will reach levels seen in the US, the risk of it settling at a higher rate than expected is far from negligible. The ECB could therefore be required to reconsider its stance, in much the same way as the Fed did a few months ago; but probably not quite to the same extent.
Written on January 2022, by Olivier de Berranger, CIO and Enguerrand Artaz, Fund Manager