On July 1, the CSO released a series of unplanned inflation statistics showing that the consumer price index (HICP – EU’s favorite inflation index) rose 9.6% in Ireland in the 12 months to the end of June. Did.
Ireland’s HICP alone was well above the EU average of 8.6%. It is also well above the latest consumer price index figures, where prices in the country rose 7.8% in the year to May.
In reality, HICP and CPI are virtually the same. HICP excludes rents, but both tend to track each other very closely, with HICP rising faster when prices start to rise and falling more rapidly when prices start to fall.
The announcement of the CSO isn’t all that surprising to us, who have been punched out by soaring prices at checkout.
Regardless of which gauge is used to measure inflation, it is now as clear as daytime that inflation remains much longer than expected by central bankers and most economists. .. The ECB’s inflation rate is projected to be 6.8% this year and only 2.8% in 2023, so I think it’s hopelessly optimistic.
Compare the current official interest rate with what is happening to the price. The ECB’s main refinancing rate has been 0% since 2019, with a marginal lending rate of only 0.25%, but it actually imposes a negative interest rate of 0.5% on deposits on eurozone banks.
The ECB has suggested raising interest rates by 0.25% this month, but plans to raise them further later this year, but official interest rates are still only a small part of inflation.
Even after the recent rise, interest rates in the US and UK are also much lower than inflation. The Federal Reserve’s main interest rate, the federal funds rate, is only 1.5pc-1.75pc, while the Bank of England’s base interest rate is 1.25pc.
When inflation, which was until recently, is very low, we all tend to focus on the nominal interest rate. This makes sense if you don’t have to worry about inflation damaging the true value of your savings or borrowing. But as it is today, everything changes when inflation soars.
Next, we need to look at the real interest rate, the nominal interest rate minus inflation, not the nominal interest rate. Then, even after the predicted increase has been implemented by the ECB, it will soon become clear that real eurozone interest rates are not only very low, but also negative.
This year’s ECB’s 6.8pc inflation forecast proved to be accurate, and even if the refinancing rate is raised by 0.25pc this month and 0.25pc in September, it will still remain at 0.5pc. This means that the real interest rate will be -6.3pc (0.5pc-6.8pc). If inflation in the euro area remains at the current 8.6%, the real interest rate will be -8.1%.
This is clearly a completely unsustainable situation beyond a very short period of time. Bond yields are already skyrocketing. Over the last 12 months, 10-year German Treasury yields have gone from minus 0.22% to nearly 1.3%, and Irish Treasury yields have gone from less than 0.1% to 1.88% over the same period.
However, the canary in the mine is an Italian bond yield, more than quadrupled from 0.75pc to 3.4pc in the last 12 months.
Is this a precursor to the new Eurozone sovereign debt crisis, either later this year or early next year? Exchequer will incur an additional € 2.4 billion annually, even if the Irish state pays creditors € 242 billion, which increases the average borrowing cost by 1%. Treasury Minister Paschal Donohoe is watching this carefully.
Dermot O’Leary, Chief Economist at Goodbody Stockbrokers, said the more complex problem is to unravel temporary factors such as food and energy prices to reach “core” or underlying inflation figures. is.
In a presentation last month, ECB Chief Economist Philip Lane set core inflation in the euro area to just under 3%. This is above the ECB’s 2% target rate, but it’s pretty shy at the current headline rate.
It is this core inflation rate, not the HICP, that the ECB focuses on when making interest rate decisions.
The ECB would have received some encouragement from the sharp declines in both energy and food prices last week.
At one point, the price of Brent crude fell to just $ 100 (euro 98) per barrel. This is the lowest level since Putin invaded Ukraine, and grain and vegetable oil prices have fallen sharply. If these commodity prices continue to fall, inflationary pressures could ease and the gap between the nominal and real interest rates could close.
But if not, the outlook is much bleak, as UK natural gas prices have skyrocketed in recent weeks.
“Risk is positive when it comes to interest rate expectations,” says O’Leary.