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November 14, 2019

European inflation can bring surprises

Europe inflationThe uncertain wage growth on both sides of the Atlantic Ocean focuses investors on a major risk to the financial markets: what if the strong recovery has led to higher inflation?

So far, there are fewer signs of renewed price pressure in the Eurozone than in the US, despite the accelerated economic growth. But according to some representatives of the European Central Bank (ECB), the higher prices are close. That would be good news for the ECB, which has been working for years to raise inflation again. But while reflecting some lighter prospects for the Eurozone, it could also lead to a more timely suspension of the stimulus program and raise interest rates, exerting pressure on the recovery of the currency bloc.

Last week the German syndicate IG Metall reached an agreement with employers in the engineering sector, which could lead to an increase in salaries of nearly 4 million people at the rate of 3.5% per year in the next two years. And while the trade union only includes workers in the metallurgy and industry sectors, talks on wage increases are often a leading indicator of the overall wage trend in the German economy.

As the country is responsible for about 30% of the Eurozone’s entire economy, it can force ECB representatives to increase their base inflation forecasts. During its December meeting, the ECB’s leadership identified “first signs of worsening wage pressures” driven by wage growth in many countries.

The Eurozone inflation declined to 1.3% in January, not very close to the ECB’s target of just under 2%. The core inflation, excluding volatile energy and food prices, rose slightly to 1% from 0.9% in the previous month.

In its December economic forecast, the ECB assumed that inflation will pick up slightly this year and reach 1.7% by 2020.

However, some high-ranking central bankers believe that the days of Europe with low or no inflation are almost over. The higher prices could lead to turmoil in financial markets. Traders have become more worried in recent days about rising inflation, which can cause the Federal Reserve and the ECB to end their stimulus policies and raise their interest rates more vigorously.

The ECB President Mario Draghi is more cautious and has repeatedly called for “patience and persistence” by the policy makers of the bank as they contemplate the pace at which the end of the stock buyout program will be cut to 2.5 trillion USD, known as quantitative easing. At the moment, it must last at least until September, and Draghi assumed it would be extended beyond that.

The unemployment is much higher than the German one in some other Eurozone economies where recovery is not so fast. It is still 16.7% in Spain and 20.5% in Greece in November, according to European Statistics Agency. Still, the lack of employment is drastically decreasing in the region, and wages start to move upwards.

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