Eurozone inflation rises to decade high of 3%

Eurozone inflation updates

Inflation in the eurozone has risen to its highest level in almost a decade, increasing pressure on the European Central Bank to slow the pace of its bond purchases.

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Driven up by the region’s recent economic rebound, August’s jump in the eurozone’s harmonised index of consumer prices to 3 per cent from a year earlier was up from 2.2 per cent in July. The rise exceeded the expectations of most economists.

Consumer prices have not risen as fast in the 19-country bloc since November 2011 when the ECB had just raised interest rates for the region, the last time it did so.

Prices in August increased or were flat year-on-year in every eurozone country. The highest inflation rates of between 4.5 and 5 per cent were in Estonia, Lithuania and Belgium. Only four eurozone countries now have inflation below 2 per cent, down from 16 countries in March.

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The price increases were driven by the economic rebound from the impact of the pandemic, higher energy costs, the reversal of last year’s German cut in value added tax and bottlenecks in supply chains. They also partly reflect last year’s delayed start to summer clothing sales in France and Italy, which were on time this year meaning prices are higher in comparison.

Germany’s Bild newspaper decried the “new inflation shock” in a front-page headline on Tuesday after the country’s inflation rate hit a 13-year high. 

In the past year, energy prices have risen 15.4 per cent, food alcohol and tobacco prices climbed 2 per cent and industrial goods prices increased 2.7 per cent. Core inflation, excluding the more volatile energy, food, alcohol and tobacco prices, more than doubled to 1.6 per cent, its highest level since 2012.

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Most economists expect inflation to fall again next year, as temporary factors fade. But the recent jump in prices still provides ammunition to more conservative ECB rate-setters: they are expected to push for a slowdown in its bond purchases under its €1.85tn pandemic emergency purchase programme when they meet next week.

“The effects of reopening and supply problems could intensify in the next few months,” said Jack Allen-Reynolds, an economist at Capital Economics. “But we suspect that they will begin to fade next year as global consumption and trade patterns return to something like their pre-pandemic norms, and producers — especially of semiconductors — are able to increase their output.”

Allen-Reynolds forecast the headline rate of eurozone inflation would drop to about 2 per cent in January and continue falling to end next year at about 1 per cent. 

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Investors seem relatively sanguine about rising inflation, which is
usually considered bad news for bond prices. But comments by several
ECB council members about a potential slowdown in its bond-buying sent
yields on German 10-year bonds up 5 basis points to a five-week
high of minus 0.38 per cent on Tuesday. Bond yields rise as prices
fall.

Inflation is rising in many countries as the world economy rebounds from the impact of the pandemic, increasing pressure on central banks to start winding back the monetary stimulus they launched last year. In the US, where inflation is more than 5 per cent, Federal Reserve chair Jay Powell said last week it would start scaling back its asset purchases this year.

The faster-than-expected rise in inflation will also provide an early test for the ECB’s new strategy, which it unveiled in July. The central bank raised its inflation target slightly to 2 per cent and said that while it was prepared to tolerate any moderate and transitory overshoot, it promised to maintain “forceful and persistent” policy to hit it.

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Salomon Fiedler, an economist at Berenberg, predicted the ECB would raise its inflation and growth forecasts next Thursday. “This could be the basis to reduce the pace of bond purchases under the pandemic emergency purchase programme in the fourth quarter, possibly to a rate between that of the first quarter and the faster rate which the ECB had adopted thereafter,” he said.

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