Why the ECB is wrong to go after the Fed: the causes of inflation are different
The ECB's move risks bringing certain damage in terms of economic growth and uncertain advantages in terms of containing inflation. Giuseppe Liturri's analysis
Very interesting data arrived between Friday and Monday on the health of the eurozone and US economies and on business expectations for the coming months.
On Friday, S&P Global published its leading indicators of economic activity for the US and the Eurozone , and on Monday, the IFO index for the German economy was published.
These are sample surveys carried out by interviewing managers and entrepreneurs who almost always describe both the direction and the intensity of the level of economic activity well in advance.
The fundamental message coming from these surveys is that both economies are experiencing a significant slowdown in the fourth quarter and, looking ahead, also in the first quarter of 2023, but this is a decline that does not continue to worsen and, in some cases, reverses the trend, while remaining in negative territory. But there are differences between the US and the Eurozone that must be underlined.
In detail, in the USA the composite index (industry and services) in December worsens again compared to November (from 46.4 to 44.6, remember that the value below 50 indicates a worsening), likewise the PMI index worsens (summary of current situation and prospects) from 47.7 to 46.2.
In summary, it seems that in the USA the pressure of demand on the production chains which are beginning to work off the delays in supplies is significantly easing and, at the same time, the upward pressure on prices is moderating. These data suggest that the Fed, with its rate hike policy (from 17 March to 14 December 7 hikes for a total of 425 basis points) is succeeding in its objective of containing inflation but at a growing cost for the 'economy. In fact, the December data are compatible with a 1.5% contraction in GDP on an annual basis.
In Europe, we are also in negative territory, but the signs coming in for the month of December show that the climate in the business world has improved slightly. The PMI index rose from 47.1 to 47.8 and the composite index for industry and services stood at 48.8 (47.8 in November).
It is true that this is the sixth consecutive month of slowdown, marked by less tension in supply chains and fewer delays in order fulfillment, but encouraging signs are emerging in terms of prospects for the beginning of 2023, which a few months ago looked worse compared to today. It is significant that weak demand is easing upward price pressures and taking away bargaining power from firms that want to pass on cost increases on selling prices.
Today's data is consistent with a drop in eurozone GDP in the fourth quarter of 0.2% and an even smaller decline in the first quarter of 2023.
The IFO index for the German economy paints a similar picture. The assessment of the current state of the economy remains largely in negative territory, at levels not seen since the 2020 lockdown, but the rebound from the lows is evident. The index of expectations improved to 83.2 (80.2 in November), that on the general business climate rose from 86.4 to 88.6. Services and all manufacturing sectors (except construction) contribute to the improvement.
Among the determining factors in the improvement in the situation and in the prospects, there is certainly the easing of tensions on the energy price front which occurred from October onwards.
These data could have important consequences on the action of central banks.
In the USA, the Fed could consider itself satisfied, having achieved the objective of containing inflation at all in all contained costs in terms of employment, wages and GDP. Let's not forget the exceptionality and speed of a rate increase of 425 points in 9 months.
In the Eurozone, where the economic cycle appears to be about 3-4 months out of phase with respect to the USA, the ECB could also moderate the pace of the hikes (so far four interventions for a total of 250 basis points). Also considering the up to now predominant role in the growth of inflation played by the energy component. It is true that, over the months, energy prices have also affected inflation excluding energy and food (so-called "core") which was still on the increase in November at 5.6%. But, as correctly pointed out by some economists, the action of the ECB – albeit dutiful, as it necessarily has to get out of the abnormality of negative rates and excess liquidity – risks bringing certain damages in terms of economic growth and uncertain advantages in terms of containing the 'inflation.
The almost flat trend in wage dynamics – very different from the US labor market, which is still relatively tense – should also lead the ECB's governing council to be more cautious than its counterparts overseas.
In conclusion, the ECB was right to make up for the time lost up to June 2022, spent figuring out what was happening, but there is no point in chasing the Fed, because the signs of a slowdown in the European economy are evident and we need to press the brake again ( raising rates again) would bring more costs than benefits.
This is a machine translation from Italian language of a post published on Start Magazine at the URL https://www.startmag.it/economia/bce-fed-cause-inflazione/ on Tue, 20 Dec 2022 06:30:07 +0000.