Inflation in Europe has fallen less than what was forecast for the beginning of the year, Eurostat announced on March 1. Initially driven in 2022 by rising energy prices, which are easing, inflation is now holding steady, particularly due to the continued rise in food prices, known as core inflation. A “worrying factor”, according to the economist Philippe Waechter and a “quite new” situation that the European economies will have to face during the spring.
Good news… misleading. The annual inflation rate in the Eurozone continued to decline in February for the fourth consecutive month, standing at 8.5% year-on-year, according to figures published by the European statistics agency Eurostat.
The peak of October 2022 (10.6%) seems distant, but it is not a reason to get excited: inflation actually fell less than what was forecast for February. Experts interviewed by Factset and Bloomberg expected rates of 8.2% and 8.3% respectively, before the European figures were published.
Although the difference with the forecast seems small, it hides a reality that contrasts with the current inflation dynamics in Europe.
Until now, inflation had been caused by the rise in energy prices, which has eased in recent months: after a dizzying 41.5% rise in October, gas, oil and even electricity prices electricity only increased by 13.7% in February of this year. But an important change has counteracted this dynamic: the increase in the cost of food, alcohol and tobacco, which has become the engine of current inflation for the first time in the last two years.
“It’s a bad surprise, we didn’t expect this situation at the beginning of the year,” explains Philippe Waechter, director of economic research at Ostrum Asset Management.
“In 2022 we wondered about the price of energy, which would trigger inflation. Currently, it is declining very significantly, but all the other elements are taking over and that is what is worrying. In particular, food prices are rising a lot and that is a factor that penalizes households”.
In a year, food prices have skyrocketed: while in February 2022 the increase was 4.2%, last month it reached 15% in the Eurozone.
“We see core inflation progressing”
Despite this increase, the peak of food inflation does not yet seem to be behind us. In European countries it could even take place in spring, particularly in France, where the industry and supermarkets have just concluded their annual negotiations to fix the selling prices of food.
The industry and the Federation of Commerce and Distribution established that the increase in prices that the large distribution sector pays to its suppliers should be around 10%… and supermarkets should pass on at least a part of these increases in the prices consumers, although it is not yet known in what proportion. But the average price of the shopping cart is likely to continue to rise in the coming weeks.
“Spring will be difficult to manage,” says the economist.
“Month after month we see that underlying inflation progresses, it is a worrying factor. Companies, especially those in the goods sector, affect the rise in energy prices in their own prices”, as evidenced in the negotiations between the industry and large distribution in France.
Core inflation, which unlike inflation excludes products with volatile prices (such as energy), but includes food, is an index “more appropriate for an analysis of inflationary pressures,” according to the National Institute of Statistics and Economic Studies (INSEE, for its acronym in French).
And in addition to food prices, Eurostat also confirmed for last month the increase in the prices of industrial goods –with an increase of 6.8% year-on-year compared to 3.1% in February 2022– and an acceleration of inflation in services –4.8% compared to 2.5% in February 2022–.
Currently, “a relay effect is taking place between energy prices and food prices”, sums up Philippe Waechter. And the economies of the Eurozone react differently to this dynamic: the inflation rate in France – weaker than that of its neighbors – increased for the third consecutive month, standing at 7.2%; that of Italy fell (9.9% against 10.7% in January), and that of Germany increased slightly (9.3% against 9.2% in January).
What will be the role of the European Central Bank in the coming months?
Despite the current inflationary dynamics, the German Federal Bank maintains that this year inflation will drop in the country: on Wednesday, March 1, it even estimated that Germany’s inflation will be 7% in 2023although initially it had been calculated at 7.2% after a previous forecast made in December.
The Bundesbank also remained firm on the need to continue raising interest rates in the Eurozone. A path that the European Central Bank (ECB) has followed since last July, when it decided to activate that economic lever, for the first time since 2011to combat inflation. Since then, the European banking institution has continued with its policy of monetary tightening and plans to do the same in March.
These new Eurozone inflation figures could even lead the ECB to raise interest rates again after March. “At this point, it is possible that we will continue on this path”, admitted on Thursday, March 2, the president of the institution, Christine Lagarde, during an interview on the Spanish channel ‘Antena 3’, without going into details about the scope of the possible increases after the meeting on March 16.
Philippe Waechter warns that this strategy is not exempt from risks in the medium term for the European economies: “Inflation does not seem to change despite the ECB’s monetary policy. The latter, by raising its rates, does not prevent the effect of incorporating energy prices on the behavior of companies”.
And the economist concludes: “If the ECB is forced to go further than expected, there is a risk of causing a much more pronounced slowdown in economic activity because companies and households will be penalized in their financing. Under these circumstances, inflation could stop, but then the risk of recession could also increase.
This article was adapted from its original in French
