Euro insensitive to inflation data

Inflation for longer

Inflation turns out to be more durable than previously assumed. The recent escalation of the conflict in Ukraine has perpetuated this tendency. The fact that Russia suspended the grain deal, which facilitated the export of important agricultural commodities from Ukraine, threatens to increase food inflation again. The increasingly detachable inflation expectations from the 2% target may be worrying.

Some investors hope that the recession in the winter half of the year will take much of the central bank's work. After all, in previous recessions, inflation has tended to fall because in their wake demand decreased significantlythus eliminating a pre-existing demand overhang that set inflation in motion.

Currently, the euro area economy operates at a very high level of capacity utilization. This is reflected in the unemployment rate, which is lower than ever since the establishment of the monetary union, and in the high proportion of companies complaining of a labor shortage. Along with supply bottlenecks in many sectors and the enormous rise in energy prices, this is one of the main drivers of the currently very high inflation, as also highlighted by the ECB in its recent study.

Demand restraining and a huge increase in costs

In the coming months, the demand will decline. This is because huge increases in energy prices are reducing the purchasing power of private households, and many companies will put off investment projects in the face of much higher costs. Additionally, there is weaker foreign demand and the first effects of the increases interest rates ECB that probably will be felt especially in the construction sector. All of this in and of itself is holding back demand and hence inflation.

At the same time, however companies face enormous cost increasesthat they want to transfer to their customers as much as possible. If they succeed, it itself causes inflation to rise. If, on the other hand, they are not able to raise prices sufficiently, they will reduce production, which is no longer profitable, as is now seen in the particularly energy-intensive sectors of the German manufacturing industry, where production has fallen by 8% since spring. In addition, there is an increase in wages.

Employees want to at least partially compensate for the real wage losses they have suffered in the last dozen or so months. This is all the more true as they increasingly doubt that inflation will soon fall back towards the ECB's target. According to surveys conducted by the European institution, the average household currently expects inflation at 3%. within three years. The tight labor market means that employees have a good chance of getting pay raises.

Source: Łukasz Zembik, OANDA TMS Brokers