Data released last week confirmed that although energy price inflation in the Eurozone remains elevated, it eased last month to 38.6 percent year-on-year from 39.6 percent. It remains to be seen whether this decline will continue. On the one hand, oil prices are once more well below the $100 per barrel threshold and even gas prices have fallen back from their summer highs thanks to government intervention. On the other hand, if gas shortages are confirmed this winter, prices are likely to rise once more, not only for gas and electricity, but also for oil which might be considered as a substitute.
Nevertheless, what is happening in the energy sector has repercussions in other sectors, such as, for example, food, alcohol and tobacco, whose prices emerged up 10.6% over a year in August. The cost of transporting goods has increased, as have the costs of heating greenhouses, running machinery, buying fertilizers, etc.
Central banks: the challenges of inflation
If inflation continues to creep in, central banks may find it harder to squeeze the genie back into his pocket. Ultimately, inflation is a matter of psychology. High inflation, if nothing is done to control it or if people doubt the ability of central banks to curb it, can fuel fears of even higher inflation that might create a self-reinforcing vicious circle. The latest ECB survey of consumer inflation expectations shows that their 1-year expectations have remained stable at 5%. On the other hand, their 3-year expectations climbed to 3.0%, once morest 2.8% previously.
An additional factor complicating the ECB’s crusade once morest inflation is the weakness of the euro. This summer, the dollar reached parity with the euro and the exchange rate now oscillates around this level. This is problematic, as energy imports are usually billed in dollars. Moreover, the euro zone has just reported a deficit in its trade balance of 34 billion euros, the second largest deficit in its history, attributable to higher energy prices which have inflated the import bill.
Therefore, it is not surprising that the ECB revised its inflation forecasts upwards in September. The Governing Council now expects average inflation of 8.1% in 2022, 5.5% in 2023 and 2.3% in 2024. Concretely, this means that the ECB does not believe that inflation will return to a level consistent to its target of 2% before 2025.
The fight once morest inflation, a priority
To ensure that inflation begins to decline, the ECB is raising its key rates at a forced march: +50 basis points in July for its first rate hike in 11 years, then +75 bp in September. Nevertheless, the inflation figures for August clearly show that there is still a long way to go. Last week, ECB Vice President Luis de Guindos said decisive action was needed to anchor inflation expectations, despite slowing growth. One might have expected an economic slowdown to naturally weigh on demand and bring down inflation. But Luis de Guindos does not see things the same way, considering that “the slowdown in the economy will not be enough to solve the problem of inflation” and that the central bank will have to continue raising its rates. However, the ECB will probably not be able to fight this battle alone. Bringing down inflation will also require coordinated fiscal action, particularly with regard to the energy sector. On this front, attention should be paid to the progress of the talks on energy at the level of the European Commission, which will be held from 27 to 29 September.
As policymakers grapple with inflation, investors would be well advised to assess or reassess the potential impacts on their portfolios. For several years until the post-pandemic inflationary surge, this was something that many investors hadn’t really had to look into. Even though investing at such a time can be perilous, it is important not to miss any opportunities that may arise to build a well-diversified long-term portfolio.
