Inflation and recession shake Europe

Inflation and recession shake Europe
Inflation and recession shake Europe

The announcement of the provisional data on August inflation in the countries of the Eurozone did not leave much room for positive comments. Average inflation was 9.08%, slightly above the 9% expected by analysts and economists and well above the previous month’s 8.87%. The so-called structural inflation was also higher than expected and reached 4.28%, while analysts were expecting 4% and last month it had reached 4.03%.

Before proceeding further, it is good to recall that these percentage changes are in relation to the prices that were valid a year ago, while by structural inflation we mean the inflation that results if we do not take into account the effect of fuel and energy, food, of cigarettes and alcoholic beverages. If we look at inflation in the individual countries of the Eurozone, we see that the most “hopeful” performance comes from France, with 6.5%, lower than July’s 6.8% and the 6.7% expected by analysts .

In Germany, inflation came as expected, at 8.8%, while the huge numbers that came from the Baltic countries made a big impression, with Estonia reaching 25.2% and its two neighbors not far behind. August’s high readings of inflation and even more so the high readings of structural inflation put the European Central Bank and Council President Christine Lagarde in quite a difficult position.

The fact that structural inflation looks very durable means that inflationary pressures are becoming more permanent, which will not please any of the Council members at all, and not just the well-known supporters of restrictive monetary policy, the so-called hawks.

Speaking of hawks, they are making no secret of their view that interest rates should rise by 0.75% next week. According to a Bloomberg report, after yesterday’s inflation news, at least six of the 25 members of the ECB Council support this aggressive move. German Isabel Schnabel, member of the executive committee of the Central Bank, Joachim Nagel, president of the German Central Bank (Bundesbank) and Robert Holzmann, president of the Austrian Central Bank have, always according to Bloomberg, are three of them.

Holtzman has even stated that he knows that there is a serious possibility of a downturn in economic activity (i.e. a recession) but he believes that interest rates have not yet risen enough to cause a strong recession. Of course, the six members cannot easily dictate a decision to a 25-member council, and there are council members such as chief economist Philip Lane, who advocates gradual moves so as not to cause disruption to the economy, markets and citizens.

But the markets seem to have made up their minds, especially after yesterday’s announcements. The economists of Goldman Sachs, commenting on the level of inflation in August, on the one hand reported that things were worse than expected and inflation stronger and on the other hand estimated that after this the ECB will definitely raise interest rates by 0.75%, the next Thursday, September 8.

Their colleagues from Bank of America expressed a similar view on the impending interest rate hike. The Goldman Sachs team adds that it now expects interest rate hikes of 0.50% in October, 0.25% in November and 0.25% in December, so that the ECB’s benchmark rates will reach year-end 1, 75%, from 0% which is at the moment, while he also estimates that the structural inflation in the Eurozone will rise even more and peak its movement close to 4.6%. We saw a similar reaction from the relevant departments of many other banks and brokerage firms.

The bond markets seem to agree with these assessments and as we read in the international news agencies, German bond prices now incorporate the certainty that the interest rate increase will be of the order of 0.75%. As we read in Reuters, August is the worst month for German bonds in at least 30 years.

This means that their yields have risen a lot, as a result of strong inflation and the change in estimates for the rise of the ECB’s reference interest rates. (When bond yields rise, then bond prices fall, since bonds that are already in circulation become less competitive than those that will be issued at a higher rate).

For example, Germany’s 10-year government bond saw its yield in August rise from 0.85% to 1.58%, while the yield on its two-year counterpart rose 0.90% in August, which was expected to since 1981. We have seen a similar rise in yields and fall in prices in the bonds of the rest of the Eurozone countries as well as the United Kingdom.

The significant rise in bond yields also implies an increase in the cost of financing the governments, businesses and citizens of the Eurozone. In today’s situation, where the cost of doing business has skyrocketed, as has the cost of living, and government budgets are close to overflowing, the rise in the cost of money is almost certain to bring recession closer, as it is expected to significantly affect the economic activity.

The explosive rise in the price of natural gas and the corresponding rise in the price of electricity to unimaginable heights in recent weeks has put the pressure on the economy even greater and has led many economists and politicians to consider recession all but certain. Already last week, before we even saw the record prices of natural gas and electricity, the economists of the Swiss bank UBS estimated that the Eurozone is already in a slight recession, from which it will emerge at some point in early 2023.

In its base scenario, the UBS team believes that natural gas will become more expensive, but there will be no shortages and no cuts in the distribution of electricity in the Eurozone countries. If the latter two occur, the decline in economic activity will be much sharper and the recession will last longer. Their colleagues at Morgan Stanley are a bit more pessimistic and expect a somewhat deeper recession that will last until the end of 2023.

However, regardless of the estimates of the investment banks, it is certain that in the Eurozone there is a great concern about the development of economic activity in the coming months and the certainty (now) that interest rates will increase significantly strengthens these fears. If the markets are right and the ECB board proceeds with an aggressive increase in benchmark interest rates, it is possible that we will see an even greater rise in bond yields.

This may create some difficulties in the financing of businesses but at the same time it may also have a side effect that may ultimately be good for the European fight against inflation: the rise in the exchange rate of the euro against the US dollar. The very large fall of the European common currency against the dollar has played an important role in the development of inflation, since it makes fuel and raw materials much more expensive than before, for citizens and businesses in the euro area.

Rising interest rates may therefore be considered a negative factor for economic growth, but if they cause the euro to rise, they will certainly do good for the economy. And of course, let’s not forget that the biggest help the Eurozone can receive in its battle against inflationary pressures is to stop the continuous rise in the price of natural gas and to disconnect the electricity market from natural gas, as we saw yesterday ( Putin’s big blackmail in Europe).

So it is not unreasonable to worry about rising interest rates and a possible recession. But the key to everything lies in overcoming the energy crisis that afflicts Europe.

The article is in Greek

Tags: Inflation recession shake Europe

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