Euro area inflation is up (estimate)

later12

along with some other less than heartening news, here:

http://www.bloomberg.com/news/2011-01-04/german-two-year-yield-near-11-week-low-on-concerns-about-euro-area-debt.html

Euro-area consumer prices rose 2.2 percent from a year earlier, the most since October 2008, the European Union statistics office in Luxembourg said today. The median forecast of 21 economists in a Bloomberg News survey was for an increase of 2 percent.

My main concern wouldn't be for sovereign bond yields or bp vacillations at this point, these things are to be expected, but rather the question about European inflation and how this might bring about an earlier than optimistically anticipated interest rate rise in the Eurozone. Most people believe the rise will not happen until Q4 2011, but could a worrying inflationary trend, combined with the recovery imbalances within the union, bring about a premature change?

lmimmfn

this was bound to happen and the interest rate increase is inevitable, its going to take us 5-10 years to recover regardless, so interest rate increases during this recession are 100% guaranteed and will make things worse, but we know that since 2008 .

Sea Sharp

Meh, I think 5 years of inflation coupled with a weakening euro is a good option for the eurozone (and countries like us in particular if it'll mean low interest rates.)

I'm not really sure about this 'inevitable' hike of interest rates that we've been all anticipating for the last few years. It's very clear that any such hike will have very negative consequences for the already struggling European economies. So a few years of inflation for France and Germany may be a necessary evil.

thebman

Sea Sharp wrote: »

Meh, I think 5 years of inflation coupled with a weakening euro is a good option for the eurozone (and countries like us in particular if it'll mean low interest rates.)

I'm not really sure about this 'inevitable' hike of interest rates that we've been all anticipating for the last few years. It's very clear that any such hike will have very negative consequences for the already struggling European economies. So a few years of inflation for France and Germany may be a necessary evil.

The problem is the German people may not be willing to take that even if it is in their long term interest as the idea of bailing out credit addicts by not trying to manage their economies will most likely not sit well.

I think one interest rate can't work across the Eurozone as you will always have booming and struggling economies across so many nations.

What is really needed is a duel interest system where countries automatically move from one to the other based on inflation rates and economic growth/contraction to try to avoid any kind of political fiddling. Some people suggested each country should set its own but this isn't really feasible either when all in the one currency I don't think and would end up being left to central banks in each country that could be too easily interfered with.

The inflation/economy criteria alone would probably be too simplistic a formula but gives the idea of an automatic trigger that decides which interest rate should apply based on whether an economy is expanding or contracting and allowing for inflation factors.

Sea Sharp

thebman wrote: »

The problem is the German people may not be willing to take that even if it is in their long term interest as the idea of bailing out credit addicts by not trying to manage their economies will most likely not sit well.

I think one interest rate can't work across the Eurozone as you will always have booming and struggling economies across so many nations.

What is really needed is a duel interest system where countries automatically move from one to the other based on inflation rates and economic growth/contraction to try to avoid any kind of political fiddling. Some people suggested each country should set its own but this isn't really feasible either when all in the one currency I don't think and would end up being left to central banks in each country that could be too easily interfered with.

The inflation/economy criteria alone would probably be too simplistic a formula but gives the idea of an automatic trigger that decides which interest rate should apply based on whether an economy is expanding or contracting and allowing for inflation factors.

Multiple interest rates just would not be practical with a single currency. I think a two-tier euro would be needed to have 2 interest rates in Europe.

You're right that the German people won't be too keen to maintain low interest rates but the alternative is simply not a viable option.
I hike in interest rates will be the straw that breaks the camel’s back for Spanish, Portuguese and Italian banks. The Euro currency might not be able to survive a hike in interest rates.

I know the German economy has had a large influence on the ECB policies in the last decade, but I think in this case if the ECB ignore the bigger picture it could be disastrous.

ardmacha

The logic of a currency union is that at this point the likes of Ireland should have virtual devaluation, with prices increases lower than the Eurozone average, while Germany should have virtual revaluation with higher inflation than the Eurozone average. Germany has a choice it can allow the PIGS trade out of their problems, and repay their loans or it can bail them out.

later12

Sea Sharp wrote: »

I'm not really sure about this 'inevitable' hike of interest rates that we've been all anticipating for the last few years. It's very clear that any such hike will have very negative consequences for the already struggling European economies. So a few years of inflation for France and Germany may be a necessary evil.

The French and the Germans have shown themselves to be unwilling to engage with lesser evils, throughout the debt crisis they have largely sought to protect themselves. That would be particularly the case for Germany. It is hard to overstate the importance to the core economies of a low inflationary rate - and this 2.2% flash figure is largely based on those economies. The reason that the ECB's governing council decided they would keep the rate unchanged was not because of their caring and compassionate nature, it was a decision taken while domestic price pressures were low and were forecast to remain low. This has now started to change, and if it continues, so too will the interest rate. That could be sooner rather than later.

Sand

Unless theres a treaty change or a change in the pattern of inflationary pressure, the ECB will have to take action to prevent inflation - price stability is the absolute ECB priority in the treaties so its not optional for them, or possible for them to ignore without being in breach of the treaties.

Given the weight of debt hanging on the peripheral economies, both public and private, it will make for an interesting 2011 as the ECB starts ratcheting up interest rates and/or ending its extraordinary support for sick banking systems.

Sea Sharp

I wonder is their any measures that the German/French governments could take to reduce inflation without needing the ECB to step in.
For example, increasing income tax?

The French and the Germans have shown themselves to be unwilling to engage with lesser evils, throughout the debt crisis they have largely sought to protect themselves.

Even with 'looking out for themselves' in mind: They have the option of allowing a few years of inflation to occur or they can raise interest rates and potentially bring down their own banks as a consequence. (Imagine large scale defaults writing off loans German banks gave to the PIIGS.)

The European banking crisis is only just beginning.

later12

Sea Sharp wrote: »

Even with 'looking out for themselves' in mind: They have the option of allowing a few years of inflation to occur or they can raise interest rates and potentially bring down their own banks as a consequence.

The real situation is more complex. Increased inflation weakens the competitive economy, this has potential to seriously damage not only the core economies in themselves but indeed to damage their ability to bail out the other peripherals when that arises. The Bundesbank and the ECB place enormous emphasis on the necessity of maintaining low inflation within the Eurozone... this is something we have all signed up to. If Irish banks and households would fail over a 0.25% or 0.5% increase then that doesn't say much for them in the first place.

The European banking crisis is only just beginning.

Eh, it's been underway for months. Expand on that?

Sea Sharp

later10 wrote: »

The real situation is more complex. Increased inflation weakens the competitive economy, this has potential to seriously damage not only the core economies in themselves but indeed to damage their ability to bail out the other peripherals when that arises. The Bundesbank and the ECB place enormous emphasis on the necessity of maintaining low inflation within the Eurozone... this is something we have all signed up to. If Irish banks and households would fail over a 0.25% or 0.5% increase then that doesn't say much for them in the first place.

Low inflation is definitely desirable for Europe, I understand and agree with this. But the usual measure to slow down inflation, by raising interest rates, will do more harm than good given how fragile a shape the peripheral economies are in.
The ECB raising interest rates would be an appropriate measure If the consequences of allowing inflation for a few years is more drastic than mass mortgage defaults, causing a large amount of banks to go bust (this would probably be too expensive for bailouts)

I believe that that scenario is more of a threat to the European single currency than a bit of inflation.
Anyway, there must surely be other means of restricting inflation...

later10 wrote: »

Eh, it's been under way for months. Expand on that?

Portugal and Spain still haven't been deal with. I'd say we'll be seeing news headlines, like the ones focused on Ireland recently, for at least the next two years.

kaiser sauze

Sea Sharp wrote: »

Portugal and Spain still haven't been deal with. I'd say we'll be seeing news headlines, like the ones focused on Ireland recently, for at least the next two years.

Ireland still has not been dealt with!

later12

Sea Sharp wrote: »

Low inflation is definitely desirable for Europe, I understand and agree with this. But the usual measure to slow down inflation, by raising interest rates, will do more harm than good given how fragile a shape the peripheral economies are in.

But it is not just 'desirable', it is a treaty requirement. It it the stated primary objective of the ECB. It isn not the ECB's job to protect Ireland, although it has found itself unhappily engaged in that task in the recent past.

The ECB raising interest rates would be an appropriate measure If the consequences of allowing inflation for a few years is more drastic than mass mortgage defaults

I am not so certain that increasing the interest rate so that it comes closer into line with inflation would cause mass mortgage default - certainly not in Ireland which is probably the most vulnerable of the peripherals to ECB rate increases. It would put households under significant pressure and damage consumer confidence, and it would be generlly deleterious to the Irish economy. But Ireland is a tiny European economy, and I have a feeling that the benefits to the core economies in terms of maintaining their output would far outweigh the negative effect on troublesome old Ireland.

Anyway, there must surely be other means of restricting inflation...

Yes and fiscal austerity is already doing that, and wage restraint, but that is not a significant problem on the continent. Any further wage restraint might damage their domestic consumption. The problem is the rise in commodities and with the emerging economies outperforming themselves in 2011, that is only going to continue. The interest rate is the elephant in the room.

Portugal and Spain still haven't been deal with. I'd say we'll be seeing news headlines, like the ones focused on Ireland recently, for at least the next two years.

Yes but I'm still not sure why you say the banking crisis is only beginning. As far as I'm concerned, the Spanish meltdown will be the end of the crisis, Europe has answered how ti chooses to deal with the debt crisis twice, and the markets are unimpressed. It will be asked next with Portugal. Europe's final answer, when it comes to Spain, will make or break the euro. At that point the crisis will end with European integration or a further collapse of the Euro. This is not the beginning. What makes you suggest two years?

Sea Sharp

later10 wrote: »

But it is not just 'desirable', it is a treaty requirement. It it the stated primary objective of the ECB. It isn not the ECB's job to protect Ireland, although it has found itself unhappily engaged in that task in the recent past.

A bit like the way all EU countries agreed to keep their deficit under to under 3% of GDP each year.
Desperate times, desperate measures. The treaty your referring to will go out the window if it's clear that it's doing more damage than good, in the same way that if every EU nation had closed their deficit to 3% of GDP in 2009 it would have done more damage than good.

later10 wrote: »

But Ireland is a tiny European economy, and I have a feeling that the benefits to the core economies in terms of maintaining their output would far outweigh the negative effect on troublesome old Ireland.

Although Ireland, as you said, is in a worse position than other EU countries, we're not the only ones in this position. So it's a case of 'maintaining core economies output, would it far outweigh the negative effect on troublesome old Ireland, Portugal, Italy, Greece and Spain.

later10 wrote: »

Yes and fiscal austerity is already doing that, and wage restraint, but that is not a significant problem on the continent. Any further wage restraint might damage their domestic consumption. The problem is the rise in commodities and with the emerging economies outperforming themselves in 2011, that is only going to continue. The interest rate is the elephant in the room.

So you're agreeing that fiscal austerity can prevent inflation in a single country. But instead of each country realising this and taking it into consideration we should instead mess with interest rates that will wreak havoc on certain EU countries in order to help others achieve what they could have done with fiscal austerity.

later10 wrote: »

Yes but I'm still not sure why you say the banking crisis is only beginning. As far as I'm concerned, the Spanish meltdown will be the end of the crisis, Europe has answered how ti chooses to deal with the debt crisis twice, and the markets are unimpressed. It will be asked next with Portugal. Europe's final answer, when it comes to Spain, will make or break the euro. At that point the crisis will end with European integration or a further collapse of the Euro. This is not the beginning. What makes you suggest two years?

In my opinion, until such a time that every Euro nation has their deficit back down to 3% of GDP, European banks will be suffering losses and decreased profits as a result of budget cuts that shrink economies.

later12

Sea Sharp wrote: »

A bit like the way all EU countries agreed to keep their deficit under to under 3% of GDP each year.

The point is that that is a domestic policy and the European Union and the European Central Bank have no muscle to deal with that. They do have muscle to deal with inflation, in fact that, as I said, is the core objective of the ECB. The ECB's job in life is to keep Euro area inflation at just under 2%. This is a legal requirement.

Desperate times, desperate measures. The treaty your referring to will go out the window if it's clear that it's doing more damage than good, in the same way that if every EU nation had closed their deficit to 3% of GDP in 2009 it would have done more damage than good.

Sure why not throw the whole thing out the window, including the ECB, since paying them back will probably do us more harm than good as well.
If inflation climbs another 2% it could shave 0.5% off European growth. A 0.5% rise in the interest rate would have no such effects. See the lesser evil?

So you're agreeing that fiscal austerity can prevent inflation in a single country

No. Absolutely not. Fiscal austerity is one measure, it cannot do it all on its own... interest rate rises are key to inflation.

But instead of each country realising this and taking it into consideration we should instead mess with interest rates that will wreak havoc on certain EU countries in order to help others achieve what they could have done with fiscal austerity.

I would suggest that inflation would wreak havoc on the Eurozone in a way that a gradual rise would not - it would only really wreak havoc in Ireland. Portugal and Greece particularly would be far less damaged.