Inflation in America is far from dead – it is still running around four decade highs and no one knows where it will settle – but there are signs the pace at which it has been rising may now be moderating, bringing some relief to hard-pressed households.
n Europe, however, we are likely to see month-after-month of new records thanks mainly to Russian President Vladimir Putin and his invasion of Ukraine which has driven energy prices sharply higher.
Although oil and gas prices were rising before the February attack on Ukraine, they have kicked up a gear since then and if you look at annualised eurozone inflation for the three months to the end of May, it is running at more than 16pc according to economic commentator Andreas Steno Larsen – in other words, much of this is a Putin price premium.
But there is a risk now of that turning into something longer-lasting as firms pass on their own increasing costs to consumers, raising the question whether Europe’s slow growth and lowflation economic map of the past 15 years is now being redrawn.
That’s a worry for Irish households who, according to a Central Bank survey, expect prices to continue to roar higher this year and also expect to have to swallow sub-inflation pay rises. It’s also worrying for small firms which are primarily domestic and don’t enjoy the pricing power and deep pockets of the multinationals.
While surging food and energy costs were responsible for most of the increase in May’s eurozone inflation reading of 8.1pc, so-called core inflation which strips out those volatile items also jumped sharply to 3.8pc, reflecting those rising business costs.
All of this means that today the European Central Bank is going to have to dramatically increase its inflation forecasts – yet again.
In March it projected CPI at 5.1pc for this year and core inflation at 2.6pc in 2022. Its forecasts had 5.6pc year-on-year pencilled in for the second quarter, yet the actual April and May outturns have averaged 7.8pc
The central bank appears to have spent all of this year chasing its tail and in April admitted that it had made the biggest quarterly inflation forecasting error since it came into existence in 1998.
Today’s ECB revisions could add 1.0-1.5 percentage points to the forecasts for this year while 2023 also looks to be in need of a dust down as the outlook stands at just 2.1pc.
What is unclear yet is whether we have entered a new era where inflation is now permanently higher than it was in the wake of the financial crisis, but still remains anchored somewhere close to the 2pc figure that is targeted by central banks, or whether we are back into an 1970s and 80s price and wages spiral.
So far, the evidence suggests that workers aren’t getting compensated for higher prices, even in the US where wage gains have been running much hotter than in Europe.
Certainly here in Ireland, wages gains are far below inflation – the latest numbers from the Central Statistics Office (CSO) show annualised average weekly earnings growth was running at 2.3pc, which is what the Central Bank of Ireland has forecast as the run rate for the year.
After inflation – which the bank expects to be 6.5pc, a number that is certainly going to have to be revised upwards as it had averaged 6.2pc already by April – real wages in Ireland will decline by 4.2pc this year.
The bank’s survey of 5,000 people showed they expected the inflation rate to average 10pc over the coming 12 months.
Despite the heightened inflation expectations, few are expecting to be compensated for this – the survey showed participants expected earnings after inflation to fall by 3.5pc.
It’s a shame the Central Bank didn’t poll on longer- term expectations because that is the key to the conundrum. If people believe inflation will return to close to 2pc quickly, then they may not press for larger wage rises.
Economists at ratings agency S&P recently noted that “once a low-inflation regime has become well established, a switch to a high-inflation regime generally requires a combination of shocks to occur”.
“The caveat with this argument, however, is that the type of shocks historically required for a shift into a higher-inflation regime are precisely those which we are experiencing now, including excessively expansionary monetary and fiscal policies,” it said.
Since the start of 2021, the share of items in the consumption basket that have seen very large price rises has increased steadily. In particular, growth in service prices has accelerated, the Bank for International Settlements noted.
Because growth in service prices tends to be more persistent than that in goods, inflation may as a result become more entrenched.
In April 2021, the CSO’s services index prices rose by just 1.0pc, but by April of this year that figure was running at 6.5pc.
AIB’s latest Purchasing Managers Index for services suggests those pressures among Irish firms are becoming more intense.
Two-thirds of firms surveyed said they had experienced a rise in input prices during May and were charging their customers more.
For this year at least it seems households face ever higher bills.
Even if the very high inflation we are currently seeing does prove to be transitory and falls to the 2pc level the European Central Bank and the Federal Reserve target, the impact of those price rises will still be with us as inflation measures a rate of change.
Part of the reason that inflation in the US may now be slowing is lower petrol prices.
But some of the expected slowdown is due to the high year-ago reading which was 5pc in May versus 2pc in the eurozone and just 1.7pc here in Ireland.
Sustained 1970s inflation may not be on the cards, but higher prices are and you will still have a permanent impairment to your spending power, unless you are very, very lucky and can negotiate a big pay rise.
