After-effects of surge in European energy prices have kept inflation higher than in the US
Europe is facing a stickier inflation problem than the US, with investors and analysts increasingly warning of the risk of transatlantic divergence in both economic fortunes and the responses of policymakers.
After surging to multi-decade highs last year, consumer price inflation in the US has fallen faster and now stands at a much lower level. Annual growth in wages for workers in the UK and many eurozone countries has overtaken the pay rises of their American counterparts in recent months.
As growth in Europe substantially weakens, the US has recorded a 2.1 per cent annualised expansion. That figure for the second quarter, coupled with signs of labour market weakness, has raised hopes of a US “soft landing” — taming inflation without a recession.
“There are real signs of divergence,” said Katharine Neiss, a former Bank of England official who is now chief European economist at US investor PGIM Fixed Income. “US core inflation has been coming off pretty consistently since about the middle of last year, but it has been slower to fall in Europe, and wage growth has been coming down faster in the US.”
Huw Pill, the Bank of England’s chief economist, said at a conference in South Africa on Thursday that Europe had “faced a different combination of shocks”, pointing out they were much more difficult for rate-setters to handle than those faced in the US, with natural gas prices on this side of the Atlantic rising to the oil price equivalent of $600 a barrel.
“The quantum of that increase [in European energy prices] has not been fully recognised in the global macroeconomic debate,” Pill added.
With both corporate and personal incomes hit harder in Europe, businesses and households have fought harder to resist losses than in the US, embedding inflation deeper.
Policymakers and economists across the US are more optimistic about the trajectory for inflation too. Most expect price pressures to continue easing — at least in the coming months — as demand moderates, lingering supply snarls unfurl and the labour market continues to cool. New data from the US Bureau of Labor Statistics on Friday showed average hourly earnings growth steadying at an annual pace of 4.3 per cent for August.
In contrast, UK pay levels rose 8.2 per cent in the second quarter. Eurozone hourly labour costs are expected to continue rising at close to 5 per cent, near their all-time high.
Goldman Sachs’ chief European economist Sven Jari Stehn said: “We expect firmer wage growth to keep services inflation more elevated across Europe than the US.”
The eurozone’s headline rate of inflation stalled at 5.3 per cent in August, as rising fuel prices and the removal of electricity and gas subsidies in countries like France caused energy inflation to rebound.
Core inflation, excluding energy and food, declined slightly in Europe’s single currency bloc. But at 5.3 per cent it has only returned to its level at the start of the year and remains close to a record high set in March.
Isabel Schnabel, an executive at the European Central Bank, warned in a speech on Thursday that eurozone inflation was likely to fall more slowly than it rose. “While firms are quick to pass large cost increases on to consumers, they may be more reluctant to pass on declines in [their] costs,” she said. In the UK, headline inflation was 6.8 per cent in July, with the core figure registering 6.9 per cent. In the US, meanwhile, headline personal consumption expenditures index inflation is now 3.3 per cent. The “core” PCE index — which strips out changes to volatile items — is 4.2 per cent.
Many economists predict lower inflation will allow the Fed to stop raising rates, while forecasting two more such moves by the Bank of England and one more by the ECB. Investors also expect the Fed to start cutting rates several quarters before the other two.
“There is a pretty big separation between what Europe is facing and what we’re dealing with,” said Peter Tchir, head of macro strategy at Academy Securities in the US. “It would not surprise me if in a year we’re worried about deflation again, rather than inflation.”
Source FT By Martin Arnold in Frankfurt, Colby Smith in Washington and Chris Giles in London SEPTEMBER 4 2023