Europe seems to have joined the race of aggressive monetary policy set by the U.S as it hiked its inter-bank rate by 75 basis points for the second consecutive time in a row. Over the year European Central Bank has surged the interest rates by 200 basis points to combat the mounting inflation. The current inflation rate in Europe hovers around 10.7% and is expected to rise further in future despite the fierce interest rates.
Sentiment data from Europe points that the zone may step into recession as PMIs and consumer sentiment reports are repeatedly in contractionary areas. Investors are of the view that demand drops may put downward pressure on red-hot inflation; however, many analysts believe that Europe may still experience growth in prices despite falling economic activity.
Although wholesale energy prices have declined over the past few months, it requires time for the prices to transfer to the end consumer and the final consumer is still stuck with high prices. France, the second largest economy in Europe, has the lowest inflation in the bloc at 7.1%, mainly due to price caps set by the government on gas and electricity. However, the government is planning to allow prices to rise by 15% in the coming year, fueling the already uncontrollable inflation. With the winter season approaching and Putin’s retaliation, analysts predict little chance of prices retracing.
Even though energy and food comprise less than one-third of Europe’s CPI, the prices of the services sector witnessed an alarming increase of 6%. Moreover, wage rates are expected to increase given the rising cost of living for labor, which may lead to wage rate spirals and increased cost of production. The public sector unions in Germany are also anticipated to demand an increase of 10.5% in upcoming discussions. Furthermore, the European Labor market is tight, giving no room for lower wages.
Even a short-lived recession might not be able to control inflation. The European Central Bank would then need to tighten the screws of the economy once more.
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