Core Inflation in the EU: Is It Ever Going to Happen?One wonders how the Eurozone will achieve higher core inflation if monetary policy slowly tightens and the economic activity slows. Should the Euro appreciate and get back above, say, the 1.20 mark against the greenback, it will be even harder for inflation to accelerate.
Mario Draghi, President of the European Central Bank (ECB) has long recognized the significance of rising inflation. Ever since monetary policy easing – through cutting rates and buying bonds in the quantitative easing programme – he believed that cheap money – and lots of it – can somehow trigger rising inflation. Theoretically, yes, it’s possible. Printing money always leads to monetary inflation – the more Euros printed, the smaller the value of the currency.
However, for underlying inflation – known as core inflation – tends to lag as it’s not influenced as much by the cheap money printed by central banks, or, in this case, by the ECB. The normal CPI measure contains prices of energies, food, and alcohol. These prices are driven mainly by the supply of money as they are hard assets. If there is an accommodative monetary policy, investors – and people – will buy hard assets such as commodities to protect themselves from inflation and these prices will go up. This gauge of inflation therefore usually rises much faster than the core inflation, when stripped of food, alcohol, and energies.
Monday’s inflation data for the month of August confirmed this theory – the Eurozone’s CPI inflation rose to 2.0%, but the core CPI stayed at 1.0%, well below the ECB’s target of 2.0%. The CPI rate has been rising steadily since the start of QE in 2015 and recently reached 2%. However, the core inflation has been stuck between 0.8% – 1.0% in the same period.
Nevertheless, in his most recent speech this week, Mario Draghi reiterated to everybody that he expects the underlying inflation to rise steadily in the next months to reach the goal of 2%. How exactly is this going to happen? Nobody knows, especially when the QE programme is about to end and the ECB could start lifting rates a year from now. Moreover, it would appear that the economic momentum in the Eurozone has reached its peak and – heading into 2019 – it may slow. One wonders how the Eurozone will achieve higher core inflation if monetary policy slowly tightens and the economic activity slows. Should the Euro appreciate and get back above, say, the 1.20 mark against the greenback, it will be even harder for inflation to accelerate.
Draghi is something of a dreamer, and we can’t take that away from him. However, the current reality doesn’t correspond to his dreams, so it appears it will be up to his successor to live up to them and make them happen.