The Euro Area Inflation Is Driven by Bad Energy Policies

Dr Ivanovitch - MSI Global
Dr. Michael Ivanovitch

The first official estimate indicates that consumer prices in the 19 countries of the European monetary union rose last September at an annual rate of 3.4% -- marking a strong acceleration from minus 0.3% during the same month of 2020.

Excluding energy prices, the inflation was a relatively tame 1.9%, given the fact that this was happening in an economy growing at an annual rate of 6.6% in the first half of this year.

Remarkably, energy prices – soaring from minus 8.2% to 17.4% in the year to September – accounted for nearly half of the euro area’s current inflation rate.

That is clearly invalidating the argument that the unfolding inflationary flare-up is “transitory” and “reversible.” No, this inflation has plenty of staying power in an environment of strong aggregate demand, abundant liquidity, zero interest rates and exploding energy prices.

The euro area governments have mismanaged their energy supplies, and that is now playing havoc with their producer and consumer prices.

Energy, and energy-related services, are part of households’ consumer baskets. That’s where energy costs have a direct, or first-round, effect on consumer price inflation.

But energy is also an important input in the production of consumer durable and non-durable goods, which are also part of broad and stable consumption patterns.

And here is what’s happening to those industrial producer prices in the euro area.

Low energy stocks pushing prices up

In the year to August, those prices surged 13.4%. But excluding energy costs, they increased only 7.4%. In other words, energy accounted for nearly one-half of the industrial price inflation in the monetary union.

With such a huge impact on industrial prices, it is obvious that energy had a key role in doubling the inflation of consumer durables’ prices to 3% in the six months to August.

This somewhat long story was meant to show the importance of energy costs for the euro area’s inflation -- with an important corollary: There is nothing “transitory” and/or “reversible” about the monetary union’s accelerating consumer price increases.

The sad truth is that the high and rising energy costs will lead to a significant deterioration of the euro area’s price stability in the months ahead.

The winter is coming, and the euro area’s energy (gas) stocks are at historically low levels of 74%-76%. That is way below their normal levels of 95%. Prices, therefore, have been pushed up because – correctly -- energy traders see no rapidly increasing supplies to stabilize the market.

To make things worse, European political games and conspiracy theories are now part of an already complicated oligopoly, where markets are made by a few big government players.

Russia, for example, provides half of Europe’s natural gas supplies. But Russia does energy business on long-term contracts. And, according to all the evidence, Russia is fully discharging its contractual obligations. Moscow, apparently, has even gone beyond the call of duty by providing recently an emergency 15% increase of gas supplies to its European customers.

In spite of that, and true to form, Europeans are now blaming Russia to cover up their disastrous energy management. Moscow, they say, is not responding faster with larger energy supplies to a roaring market demand.

Europeans have written their own recession scenario

Those manifestly ill-judged accusations prompted last week the German Chancellor Angela Merkel to an unusual defense of Russia. She reminded Europe’s would be energy customers to pass contracts with Russian suppliers.

At the same time, though, Merkel, and her EU Commission sidekicks, appear to be stalling the service entry of the star-crossed Nord Stream 2 gas pipeline. As things now stand, it could be at least another six months for Germany to get its act together.

Meanwhile, the Russian Nord Stream 2 operator is reportedly saying it’s ready to supply 5.6 billion cubic meters of gas by the end of this year. If true, that would be roughly 10% of the pipeline’s annual capacity.

So, there it is. The euro area governments have caused a chaos, soaring energy prices and accelerating inflation validated by the European Central Bank (ECB). In the process, the Europeans have written their own economic recession scenario.

Remember, price stability is the ECB’s charter mandate.  

But relax, says the ECB’s Spanish board member. According to him, the euro area price stability is still “structurally” sound because wages are not rising. His German colleagues must be utterly horrified by such arguments as they look at their broad-based and accelerating 4.1% inflation – the highest reading since 1993.

The euro area’s tame wage growth in the first half of this year cannot continue because (a) the economy is currently on an estimated growth path of 5%, whereas its noninflationary growth potential is less than 1%, (b) that strong economic growth is prompting a rising demand for labor, with the unemployment declining by 261,000 between August and September, and (c) job vacancies are increasing, and that will inexorably lead to rising wage claims.

The only way the ECB can restore stable prices is by raising interest rates to depress demand and price pressures in euro area’s labor and product markets. You can take that to the bank.