Comments earlier this week from Jean-Claude Trichet got people thinking that the ECB was about to get hawkish on inflation, and that’s helped the euro become a major winning currency this week
Societe Generale argues that’s nonsense.
That’s because what’s driving inflation is food prices, energy prices, and increases in the VAT and other taxes. And those inflation factors wouldn’t be impacted by a rate hike.
Although these concerns cannot be dismissed, the key point about higher inflation being driven mainly by the volatile components is that they have nothing to do with domestically- generated inflation pressures, either demand or cost driven, and so higher interest rates would not have any direct impact on these at all. Moreover, as the name suggests, they are volatile, and so their trend could quickly reverse.
And even if food and energy prices remain high, wages are suggesting inflation could still easily decline
Every available measure of wage growth is pointing to very low growth and continued slowing, with unit labour costs declining outright. Given the lag between wages and inflation, cost pressures in the economy should be very subdued for many quarters to come.
Note, pretty much every driver of wages is in decline if not already in negative territory.
Photo: Societe Generale
Bear in mind one thing… just because it doesn’t make sense to beat food/energy inflation via rate hikes, it doesn’t mean it won’t be tried by frustrated central bankers. In fact, pre-crisis, the ECB made this same mistake. They could easily do it again.