The ECB is facing a choice between economic growth and inflation

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by Shaun Richards

Today gives us an opportunity to look at the implications of the stagflation pressure being applied by the war in the Ukraine. We can do so via an area much of which is geographically close and to that end we can note this from France earlier.

Year on year, the Harmonised Index of Consumer Prices should rise by 4.1%, after +3.3% in January. Over one month, it should increase by 0.8%, after +0.2% in the previous month. ( Insee )

The first point is that this gives us an idea of what inflation would be if we take away the energy price surge. This is because due to the upcoming election France has decided to cap domestic energy price rises at 4% for this year. There is a cost to this which is being applied to EDF and I have seen estimates of the order of 8 billion Euros. Thus the energy sector in France is only seeing prices rise at an annual rate of 21% which is much lower than elsewhere.

If you are wondering what prices are rising here is some detail on the monthly changes.

The prices of manufactured goods should rebound due to the end of winter sales. The prices of energy should accelerate in the wake of those of petroleum products. Those of services should increase slightly, linked to the rebound in transport service prices. The prices of food and tobacco should slow down.

I am not so sure about their view of food inflation because of the issues with fertiliser and wheat prices we noted only yesterday. Indeed it does not fit with another official release from France today.

In January 2022, agricultural producer prices went up by 15.8% year on year (after +17.7% in December 2021). Excluding fruits and vegetables, agricultural producer prices rose by 17.8% year on year (after +19.0% in December) and by 1.0% over one month (after +0,3%).

But let us move on with the knowledge that in France even with a fair bit of the energy price crisis removed inflation is essentially double the ECB target.

How does the ECB respond? Here is Isabel Schnabel from yesterday.

In the euro area, inflation has proven more persistent and more broad-based than expected, labour market slack is being reabsorbed at a faster pace than anticipated and pipeline pressures continue to build up.

Not a mea culpa but some sort of admittal albeit avoiding how wrong she has been. But then she reverts to type.

In this environment, monetary policy needs to ensure that the forces pushing up prices today will not jeopardise price stability over the medium term. Households and firms count on the ECB to protect their purchasing power without putting at risk the current strong recovery from the crisis.

Yes she is completely ignoring the fact that purchasing power is falling now and the second sentence is pretty much laughable. They prefer their models and theory to reality every time.

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What about economic growth?

The problem is that we are also facing a deflationary shock and the first estimates are beginning to arrive.

economists have reduced their forecasts for EA growth in Q2 and Q3, and now expect growth of 3.3% this year (down from 3.8%) ( @acemaxx )

The exact numbers will depend on factors we do not fully now yet. For example we know that the price of oil has gone higher with both inflationary and deflationary economic effects. For example front month Brent Crude Oil futures have fallen back towards US $95 this morning after going above US $102 yesterday.

There is also the issue of what to do about sanctions and Russian gas?

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European natural gas prices halted a record-breaking rally, as Russian flows to the continent ramped up 🇷🇺

📈 Utilities order more gas under long-term contracts with Gazprom
📉TTF futures fell as much as 21% Friday (But are still up ~50% for the week)

So whilst again things are volatile Europe is buying more expensive gas which is deflationary. Also some parts of Europe seem to be worried about their banking sector.

Germany, Italy, Hungary and Cyprus are blocking a decision to disconnect Russia from the SWIFT network following its full-scale military attack on Ukraine. ( @vtchakarova)

Actually Germany has just confirmed this.


Money Supply

This mornings numbers can on today’s theme be looked at two ways. Let us start with the shorter-term and narrow money.

Annual growth rate of narrower monetary aggregate M1, comprising currency in circulation and overnight deposits, decreased to 9.0% in January from 9.8% in December.

This can be given an anti-inflationary spin because the monthly increase at 32 billion was less than half of the recent average. But that means that the short-term economic growth push will be weaker too. Also as an aside most of it was currency ( 17 billion) were some going to cash ahead of fears for what might happen in Ukraine? It would be interesting to know which countries the cash demand was seen in.

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If we look ahead to the medium-term the picture does not change much.

The annual growth rate of the broad monetary aggregate M3 decreased to 6.4% in January 2022 from 6.9% in December, averaging 6.9% in the three months up to January.

The fall is essentially the narrow money one so we are left with the view that with lower growth the inflation push remains rather similar to the one now.


Regular readers will be aware of my theme that faced with a choice between economic growth and inflation they will choose growth 100% of the time. Or rather to be precise short-term growth as I would argue ( and did in last week’s podcast ) that higher inflation reduces growth over time. It is kind of ECB Chief Economist Phillip Lane to back up my theme so let me switch to his words this morning.

#ECB chief economist Philip Lane told policymakers meeting in Paris the Ukraine conflict may reduce the euro zone’s economic output by 0.3%-0.4% this year, four people close to the matter told @Reuters

So at this point similar to Credit Suisse. But there was more.

Severe scenario is a cut close to 1% – sources ( @DailyFXTeam )

So at this point the talk of interest-rate hikes fades although as I was not a believer that is a minor change. But that is more as we see the PT campaign beginning as to how to deal with the issue of higher inflation.

ECB‘s Lane also told meeting there would be significant increase to 2022 inflation forecast, hinted at inflation below target at end of horizon – sources ( @Sino_Market)

You ignore the fact that the inflation you have told people is going to fall will rise and expect them to believe your next forecast. Apart from the fact that looking 2/3 years ahead is frankly ridiculous right now he is plainly clearing the theoretical decks so that the ECB can ease again if it feels it is necessary.

Or if you prefer they choose theory over reality every time.

Does anyone know the way, did we hear someone say
(We just haven’t got a clue what to do)
Does anyone know the way, there’s got to be a way
To blockbuster ( Sweet )


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