The surge in energy and food prices that followed Russia’s invasion of Ukraine has left the eurozone with higher inflation and weaker growth than in the U.S. When ECB policy makers raised the bank’s key rate last month, they signaled that they might pause at their next meeting, which is scheduled for Sept. 14.
Since then, there have been signs that the economy is weaker than they had anticipated, but inflation has been stronger.
The European Union’s statistics agency Thursday said consumer prices were 5.3% higher in August than a year earlier, unchanged from July. That is well below the 10.6% peak reached in October 2022, but substantially above the ECB’s 2% target.
Economists had expected to see a decline in the inflation rate, which rose in both France and Spain, two of the eurozone’s largest members. The surprisingly rapid rise in prices increases the likelihood that the ECB will raise its key rate for a 10th time next month.
“Should we judge that the policy stance is inconsistent with a timely return of inflation to our 2% target, a further increase in interest rates would be warranted,” said Isabel Schnabel, a member of the ECB’s executive board, on Thursday.
The inflation surprise was largely due to energy prices, which had declined in recent months but rose in August. The core rate of inflation, which excludes volatile items such as energy and food, fell to 5.3% in August from 5.5% in July.
One worry policy makers have is that inflation isn’t falling fast enough to persuade workers not to press for large pay rises to protect their spending power—a mechanism that has historically made inflation stickier and harder for central banks to bring down.
Germany’s statistics office Tuesday said that wages were 6.6% higher in the three months through June than a year earlier, the largest increase since the series began in 2008. That was just enough to outpace the rise in consumer prices, leaving German workers with their first rise in real wages for two years.
The ECB’s own measure of wages negotiated by labor unions and similar groups across the eurozone as a whole recorded a 4.3% increase in the second quarter, unchanged from the first three months of the year and an indication that inflationary pressures may have steadied.
Other recent indicators had been pointing to a weakening of the eurozone’s economy after it weathered the initial phase of the war in Ukraine better than economists had anticipated, leading to speculation among economists that the ECB might keep rates unchanged in September.
“The activity data has been quite weak,” said Silvia Ardagna, an economist at Barclays. “The weakness has extended from the manufacturing sector to the services sector, and Germany has been the weakest economy.”
Bank lending to households and businesses has slowed, an indication that the cost of borrowing is cooling investment and weakening economic growth. That is likely to continue, since surveys of businesses and households recorded a sharp fall in confidence during August.
Separate surveys of purchasing managers released last week pointed to the largest decline in business activity since April 2013, if the months following the outbreak of the Covid-19 pandemic are excluded.
“Contraction risks are certainly much higher than they were a few months ago, particularly in Germany,” said Rory Fennessy, an economist at Oxford Economics.
Complicating the ECB’s work, the growth paths of eurozone members have diverged this year. Southern European economies such as Spain have benefited from a revival in international tourism, with that country reporting a 41.7% rise in visitors from the U.S. during June compared with a year earlier.
At the same time, manufacturing-reliant Germany is suffering from weak global demand for goods as consumers give priority to spending on the services they were denied during Covid-19 restrictions. Its economy flatlined in the three months through June, and its central bank doesn’t expect a return to growth this quarter.
Significantly, the surveys of eurozone purchasing managers indicated that new hiring stalled, with factories reporting that they cut payrolls for the third straight month. Figures released by Eurostat Thursday showed the number of workers without jobs in the eurozone rose by 73,000 in July, the first increase since January.
Separate figures released by Germany’s employment agency recorded a new increase in joblessness in August, casting a cloud on what had been among the healthiest aspects of the German economy in recent years—its strong labor market and low unemployment.
“The summer break and the weak economy are leaving their mark on the job market,” said Andrea Nahles, chairwoman of Germany’s Federal Employment Agency.
Europe’s jobs markets have been a bastion of resilience since Covid-19 restrictions were lifted, with low unemployment and a general shortage of labor helping to raise wages. A labor market reversal now would add a new sign of weakness for the region.
Write to Paul Hannon at [email protected]
