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Analytics, 01 July 2022

The Eurozone hits record 8.6% Inflation in June

Inflation in the Eurozone surged past expectations to a new record high. The annualized Eurozone Harmonized Index of Consumer Prices (HICP) surged by 8.6% in June vs. the previous reading of 8.1% in the month of May. This is according to the latest data published by Eurostat showed on Friday.

Economists polled by Reuters had expected Eurozone inflation of 8.4 percent which was surpassed. The record high has been the highest since 1999. Nearly half of the countries in the currency area have now reached double-digit inflation. Unemployment in the 19 countries that share the euro fell to a new record low of 6.6 percent in May, which is likely to add upward pressure on wages. The ECB has forecast that wage growth in the bloc will double to 4 percent this year.

The inflation of 8.6% is driven primarily by energy prices, fueled partly by Russia’s war in Ukraine, even as food and services also made a marked contribution. After Russia reduced natural gas supplies to Europe, energy prices rose to an all-time high for the Eurozone of almost 42% in June. Tobacco, food, and alcohol prices in the bloc were up 8.9 percent. This reflects the disruption to supplies of agricultural commodities that were disrupted by the Ukraine war.

Fuel prices rose by 41.9% in June while food costs increased by 11.1%, a particular concern for governments because lower-income families spend a disproportionate portion of their cash on these items.

The bloc’s HICP figures hold significance, as it helps investors assess the European Central Bank’s (ECB) monetary policy normalization path.

The European Central Bank

The European Central Bank (ECB) manages the euro and frames and implements EU economic and monetary policy. It keeps prices stable, thereby supporting economic growth and job creation. They have vowed to tackle the surge in prices and are due to meet in late July to announce its increasing rates.

The ECB has had negative rates since 2014 but it has said it could return to positive territory this year. It has said it will hike again in the month of September. Claus Vistesen, an economist at Pantheon Macroeconomics, said the bigger than expected rise “increases the risk” that the ECB will raise rates by more than its planned quarter percentage point at its meeting in three weeks’ time, adding the central bank was “miles behind the curve”. They are facing high political pressure high to bring energy and food prices into check.

At the European Central Bank (ECB)’s last meeting, policymakers agreed to the bank’s first interest rate hike in more than a decade. The quarter-point rise, set to take place at its next meeting on July 21, will raise rates from their historic lows.

“We will go as far as necessary to ensure that inflation stabilizes at our 2% target over the medium term,” ECB head Christine Lagarde said on Tuesday. “We are still expecting positive growth rates due to the domestic buffers against the loss of growth momentum,” Lagarde said earlier this week. The ECB forecast in June a GDP rate of 2.8% for the region this year. New forecasts will be published in September.

Sweden’s Riksbank this week accelerated the pace of its rate rises to 50bp in response to soaring inflation, mirroring similar moves by central banks in Switzerland and Norway. The US Federal Reserve last month raised interest rates by 75bp.

The ECB inflation target is 2%.

The effect of ECB interest raise

EUR/USD has fallen over the past few days. In the view of an economist at Commerzbank, inflation data from the eurozone is unlikely to change the European Central Bank’s (ECB’s) cautious course, therefore, the pair is set to stay under pressure.

Core inflation, excluding more volatile energy and food prices, slowed slightly to 3.7% in June, reflecting cheaper public transport due to government subsidies. These measures included Germany’s temporary €9 monthly train ticket, which helped to slow the country’s inflation rate to 8.2%. Services price growth in the Eurozone slowed to 3.4%, while non-energy industrial goods prices continued to accelerate at 4.3 percent.

Because the countries in the Eurozone all have different economies, the situation in each one varies. While inflation in Germany and the Netherlands dipped slightly in June, Spain set a record, hitting double digits for the first time since 1985. For the three Baltic States in northeast Europe — Latvia, Lithuania, and Estonia — prices that high have been a reality for months.

Below is a brief analysis of inflation in various Eurozone countries:

Estonia

Estonia has recorded the highest annual inflation rate in the Eurozone at 22%. Its neighbors on the Baltic Sea, Latvia is at 19% and 20.5% for Lithuania. Their efforts to replace Russian energy have left them exposed to exorbitant prices on the spot markets. The three countries lack domestic energy sources.

France

France has kept its inflation rate comparatively low, at 6.5 percent in June. This is because they have a diversity of energy sources. France has taken offline several nuclear reactors recently. The country is less reliant on fossil fuels which have protected them from the worst of the fallout from Russia’s war in Ukraine.

Spain

Spain reached an inflation rate of double digits of 10% in June for the first time in 1985. The high price of energy is largely to blame, along with increases in the price of food. The government in Madrid passed a €9 billion euro ($9.45 billion) relief package, including subsidies for transport and an 80% reduction in taxes on energy, to help vulnerable households cope

Germany

The Euro area figures are reported a day after Germany’s annual inflation for June eased from a record high, arriving at 8.2% while missing expectations of 8.8% following an 8.7% increase reported in May. Analysts pointed to government programs, including one encouraging the use of public transit with a €9 monthly pass and a cut in the country’s notoriously high tax on energy, as reasons for the dip, but do not see the movement as a trend.

“In our opinion, there are still no compelling signs for the strong upward inflation spiral to lose steam any time soon,” Deutsche Bank said in a research note, blaming persistent supply bottlenecks and energy price pressures.

Conclusion

On a brighter, note, the region’s manufacturing sector continued to expand in June, activity slowing by less than feared. Tougher times remain ahead, however, with the risk of a complete stop to Russian gas exports threatening to force countries to impose rationing. Gazprom’s (MCX: GAZP) stock fell over 30% in Moscow on Thursday after the company said it wouldn’t pay a dividend, in what appeared a preparation for a sudden stop in payments from customers.

Today’s inflation data from the Eurozone is unlikely to provide any new momentum. Some inflation data from individual countries have already been published, and it looks as if the rate of inflation in the Eurozone might have crept up further in June. Christoph Weil, an economist at Commerzbank, predicted Eurozone inflation would be 7.5% by the end of this year, well above the ECB’s 2% target.

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