Common and Unique Threads of European InflationJanuary 20, 2023
We got consumer price reports for many European countries this week. The main story for the Eurozone is still one of sticky inflation driven by elevated food and fuel prices, though there are some differences emerging among the major European economies. In this analysis we are using EU harmonized consumer price indexes (CPI) produced by Eurostat, rather than those of each country.
Let’s start with the UK. While headline inflation appears to be slowly rolling over, core inflation is still arguably rising, even when we strip out the significant impact of food and fuel. The culprit here appears to be accommodation services, i.e., hotels. There appears to be significant energy inflation passthrough in British hospitality.
Next, let’s look at France. Similar to the UK, core inflation is arguably still rising while headline inflation is slowly rolling over—all at lower rates than the UK. The likely reason for the higher level of core inflation in the UK is the energy price pass-through. As can be seen below, gas, electricity, and solid fuel (coal) prices are rising at far lower rates than in the UK. This permeates accommodation services too. In a Guardian article from November 15, 2022 titled Long queues at French petrol stations as fuel subsidy down the author states “France claims it has been the most generous country in Europe in helping people deal with the cost of living crisis, capping gas and electricity price increases and offering a government sponsored fuel rebate, which has cost the state more than 7 billion Euros. So, the inflation pressure is there, the government is just shielding its citizens, picking up some of the cost.” Way to manipulate the stats, France!
Lastly, looking at Germany, core inflation is clearly not rolling over like headline inflation. It appears to be accelerating the most of the three countries. Germany has had a complex web of fuel subsidies over the last year. A recent Guardian article, Germany to pay December gas bills for households and businesses, begins, “The German state is to pay this December’s monthly gas bill for all households and small-to-medium-sized businesses, according to a phased two-stage cap on energy prices recommended by a government-appointed expert panel on Monday.” The second stage comes into play in March 2023, when the government will spend $56 billion to cap the cost of gas and electricity for households and businesses. We can see the impact on December’s results, with fuel prices dropping significantly.
With all this said, it is clear Europe, despite attempts to suppress, has an inflation issue driven by food and fuel. If market forces were not interfered with, we suspect French and German inflation would look more like the UK’s.
It is no surprise when looking at Bloomberg’s World interest rate probability model for the UK, using overnight index swaps (OIS), that more rates hikes are assured, taking the terminal rate to 4.5%.
Using the same function, looking at the EU’s expected rate increases, we see more rate hikes coming, if for no other reason than they are starting at a lower base. Terminal rates look to peak around 3.3% by the fall. We can’t help but wonder what the rate trajectory would like without the “most generous” or even just “multi-billion dollar” fuel subsidies.