Eurozone Inflation Surges

Eurozone inflation increases to 2%. Will it move higher from here into the end of the year? This is highly probable as the economy shifts into a higher gear. Higer inflation is not a big surpirse given the environment we are in, but these numbers are starting to make people pay attention. ​

​Inflation is coming back at a significant rate of knots at the same time as the economic recovery builds momentum. All eyes now turn to the ECB, but it is highly unlikely that they will be talking about tapering at the June meeting. In recent weeks we have heard from various ECB speakers talk against premature tightening and that inflation is expected to be temporary.

What is Driving Inflation?

Energy inflation is the main culprit for the increase in prices. Oil prices have increased significantly over the last year and even with recent sideways movment since Febraury , Eurozone pertol prices hvae continued to rise modestly, reaching the highest level since mid-2019 two weeks ago. In conjunction with base effects, this has pushed energy inflation up from 10.4% in April to 13.1% in May. However, the base effect will moderate and this will reduce the impact of emergy inflation over the coming months, but don't think that this is the end to higher inflation.

Inflation on goods will increase too and we are already seeing signs of this with higher input costs in manufacturing as well as supply chain issues, shortages and high capacity utilisation which are contributing to higher price pressuress. In May, it increased from 0.4% to 0.7%, and this is likely to continue trending up as supply chain issues continue for several months more and demand for goods remains strong.

For services, it is a bit slower as COVID-19 restrictions are still in place in many countries. Reopenings are underway across the Eurozone but it is still a bit early to see the effect of these showing up in the numbers just yet and we may ned to wait until June to see this. 

Declining Unemployment

Unemployment declined to 8% in April as the labour market continues to improve resulting from the lifting of COVID-19 restriction. However, the unemployment picture is affected by the furlough schemes that are still in place across the eurozone. This results in a very low unemployment rate and it will be intersting to see what happens when the furlough shcemes end. A strong economic recovery will ppotentially limit any layoffs that are delayed becuse of the furlough but we have to take into account that businesses have had to restructure through this pandemic and the lockdowns in order to survive. Cashflow and balance sheets have been damaged and there will be a lot of work to recover from this. Fortunately, there is pent up demand that will help in this recovery an potentially limit any impact on the labour market. We are already seeing strong demand which will boost GDP but also add to inflationary pressures.

Higher Inflation - Temporary or Structural?
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With goods and services inflation set to increase more due to the reasons already mentioned, the question becomes, is this temporary or is this structural? ther eis no crystal ball for this and three will be extended debate on this for months to come. The economic recovery is building momentum but at some point after a few months of strong numbers, this will level off and we'll also see supply chain issues easing. As this happens, it is likely that in early 2022, we'll see inflation moderating.