Euro zone inflation equals all-time high as growth accelerates

Euro zone inflation shot past expectations this month to equal its all-time high, creating a policy dilemma for the European Central Bank which has consistently underestimated the stress created by the economy’s reopening from Covid-19 lockdowns.

Growth has soared as consumers return to stores and venues but many businesses have been unable to keep up with demand, putting pressure on prices which are already being driven higher by the rising costs of commodities.

Inflation in the 19 countries sharing the euro rose to 4.1 per cent in October from 3.4 per cent a month earlier, beating a consensus forecast of 3.7 per cent. That reading is the highest since 2008 and equals the all-time high for the time series launched in 1997.

In Ireland, the rate was reported at 5.1 per cent, compared to 3.8 per cent in September.

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Tánaiste Leo Varadkar says he expects inflation “to peak and fall” in Ireland next year. But he warned the “era of low interest rates is probably coming to an end”, predicting many central banks will start to pull back on quantitative easing measures and low-interest rates introduced in recent years.

While inflation across the euro zone was mostly driven by higher energy prices and tax hikes, growing price pressures from supply bottlenecks were also visible in rising prices for services and industrial goods, data from Eurostat showed on Friday.

Although energy prices accounted for the biggest chunk of inflation, underlying prices were also above 2 per cent, which ECB policy hawks may seize on to argue that it is time to dial back extraordinary stimulus.

The economic boom was also clear in growth figures. The euro zone economy grew by 2.2 per cent in the third quarter compared to a year earlier, its fastest pace in a year and also well ahead of expectations, as businesses reopened. It is now set to hit its pre-crisis size before the end of the year.

This outperformance came even though Germany, the bloc’s biggest economy, struggled as a chip shortage held back production in its vast car manufacturing sector.

While growth is seen as healthy as the economy makes up ground lost to the pandemic, the inflation figure is likely to raise concerns among ECB policymakers.

Twice ECB target

At 4.1 per cent, the euro zone inflation rate is already more than twice the ECB’s target and is likely to accelerate further in the coming months before a slow retreat next year when some technical one-off drivers get knocked out of year-earlier figures.

All indicators suggest that inflation will decline more slowly than ECB policymakers once thought, raising the risk that high prices, even if temporary, could become entrenched in wages and corporate pricing structures.

ECB president Christine Lagarde took a more cautious tone on inflation on Thursday, warning that supply disruptions would last longer than previously thought, keeping consumer price growth higher for longer and putting pressure on wages.

But she insisted that inflation will fade back below the ECB’s target over the medium term, so that no policy response is required for now.

Adding to inflation concerns, an ECB survey on Friday indicated that more than 30 per cent of companies surveyed by the bank expected supply constraints and higher input costs to last for another year or longer. A slightly lower percentage of respondents predicted difficulties would last another six to 12 months.

Firms also reported “a scarcity of applicants” for jobs as people changed profession, country or lifestyle, which was likely to result in wage increases.

Mr Varadkar ruled out reopening the budget to introduce measures to mitigate against rising prices saying a number of measures around income tax and welfare increases were included in Budget 2022.

“The budget is done and the Finance Bill reflects that. We’re not going to reopen the budget.” – Reuters