Last week Croatian Bureau of Statistics released October inflation data which showed that inflation continued increasing in October and stood at 13.2% YoY which is the strongest increase in at least 24 years. Inflation rates are increasing in the euro area as well while on the other side of the Atlantic it seems like the peak of inflation is behind us. In this article, we are looking at the main drivers of inflation in Europe and the differences between the US and Europe.
Inflation is the main macro theme in 2022 coupled with strong monetary policy tightening across the globe. As we were in a regime of very low or even negative inflation for the last few years, most of the investment strategies were to increase the risk profile and increase the duration of equity and bond portfolios to catch a few basis points more. And the strategies were successful until the consequences of the mega easing by both fiscal and monetary authorities due to the covid crisis. And for 12 months the market was listening to central bankers saying that inflation is transitory until Mr. Powell one year ago stated that we should retire that word and started a great U-turn from dovishness to significant hawkishness. Most central banks followed to curb inflation and to ensure markets that inflation will be put under control. This led us to one of the worst years on record for the asset classes with the only commodity complex being green YTD. Now we see that investors are waiting for one piece of information and one piece of information only each month, and that is inflation data. PPI, PMI, retail sales, or some other data are only viewed through the lenses of smaller or bigger inflation data for each month. October’s inflation disappointment in the US that was released on November 10th resulted in confirmation of a bullish trend for duration trades while EURUSD increased to almost 1.05. This showed how much cash is just waiting for inflation to subside to enter markets. However, it is all but clear where inflation is headed and whether will it decelerate to 2% or somewhere higher i.e., 4% or more. In any case, headline inflation stood at 7.7% YoY which was the lowest level since January 2022 while the main shock was core inflation that increased by ‘only’ 6.3%, undershooting expectations by 30bps. Deceleration was obvious in almost all sectors with healthcare services and prices of used cars being the biggest drivers.
Global bond, Equity & Commodity performance
Source: Bloomberg, InterCapital
On the other side, inflation still did not see its peak in the euro area, as October’s inflation came at 10.6% which is the highest price increase on record. It is obvious that energy prices have driven the largest part of the inflation but higher energy prices resulted in large food inflation that stood at 15.5% in October. Services inflation lagged by rising only 4.3% YoY but still being at multi-year highs and with service inflation showing to be sticky in the past we do not expect it to decelerate dramatically soon. Talking about highs, October’s data showed that the highest inflation rate was seen in Estonia, Lithuania, and Hungary which all stood above 20% YoY, while the smallest was in France (7.1%) and Spain (7.3%). On Monday we witnessed a sharp fall in German PPI driven by energy prices, and this is most likely a signal for deceleration in goods inflation, but service inflation could still show some strength as stated above meaning that we could still see higher numbers in Europe.
Croatian inflation stood somewhere in the middle, rising by 13.2% which was the largest price increase according to the CBS data. The largest contribution to the growth rate of the annual index came from food (5.11%) and housing and utilities (2.72%). However, one should bear in mind that most of the utility prices were frozen by the government meaning that households did not feel any direct impact of the energy prices skyrocketing. The service sector prices increased dramatically, with restaurant and hotel prices rising by 17.8% YoY and we hear that many hotels plan to keep increasing prices for the next tourist season as well.
All in all, there are some signs that inflation pace could lower by a bit but we do not think that we are once again going to the below 2.0% inflation environment. We could see some months in the following period with negative MoM inflation but that will be a consequence of a recession in some parts of the global economy rather than structural deflation again. We expect inflation to keep being above the last decade’s average in both Europe and US due to de-globalization that was confirmed in 2022 with the war in Ukraine and Taiwan situation. Also, one should not forget about covid consequences that will most likely change the labor market forever, with workers being in a better position which could drive a faster increase in wages.