Inflation is nearing target – but the squeeze will continue

Inflation has been slowing down for nine months in Portugal and is already around 2% in four Member States, but looking at the general scenario in the Eurozone, the battle is not over yet

After a spike in prices last year, in the aftermath of the pandemic and with the outbreak of war in Ukraine, inflation is on a downward trajectory. In Portugal, it has already been slowing down for nine months and reached 3.1% in July, closer to the European Central Bank’s target of 2%. However, the central bankers are looking at the Euro Zone, which despite having also registered a slowdown and hovering around 5%, still continues to give cause for concern, so the tightening of monetary policy should continue.

The decline in the inflation rate in Portugal is “good news” for the economists interviewed by the ECO. But although Portugal is on a path of reducing inflation, “what matters” in particular for ECB decisions, which affect the Portuguese, “are the data from Europe”, points out Pedro Braz Teixeira.

Source: INE

Inflation in the Euro Zone “is falling but underlying inflation has a very slow pace” of slowdown. The peak of this indicator, which excludes more volatile prices such as energy and unprocessed food products, was 7.5% in March this year and “has not yet dropped even one percentage point from the maximum”, stresses the director of the Research Office of the Forum for Competitiveness. “While the year-on-year inflation rate has dropped to 5.3%, the underlying has great resistance to lowering”, he adds.

Eurozone inflation “moderated 0.2 percentage points to 5.3% in July, driven by lower food and energy inflation, while underlying inflation remained stable at 5.5%”, as highlighted by Oxford Economics, in a note of analysis. “The latter was slightly disappointing and reflects distinct trends in terms of further easing in commodity inflation but a renewed rise in services inflation, which rose 0.2 percentage points to 5.6%.” For analysts, “components related to vacations drove this increase in services”.

Still, the slowdown in both rates “is good news”, in addition to the fact that it is “good that at least one country is below 2% [a Bélgica]”, and other countries close to this number, such as Luxembourg with 2%, Spain, which is the largest country with the lowest inflation, at 2.1%, followed by Cyprus with 2.4%.

There are, however, discrepancies, notably that “Germany is out of date, with a very ungrateful set of indicators: it has one of the worst results, in recession, inflation was supposed to go down”, he stresses.

Portugal has the seventh lowest rate in the euro, remembering that the indicator used for European comparisons is the harmonized index of consumer prices, which is 4.3%. The highest values ​​are recorded in Slovakia (10.2%), Croatia (8.1%) and Lithuania (7.1%), still representing, for these countries, a deceleration compared to the previous month. As can be seen from the map, for the countries whose data are already available, those closest to the war end up having higher prices.

Ricardo Ferraz points out that “inflation is converging to 2% both in the Euro Zone and in Portugal, we cannot dissociate from the ECB’s strategy of raising rates despite the high costs that this has – the economic and social impact”. “The dose that was being used was giving results and increases take some time to take effect”, he stresses, although he admits that he has “doubts” about the increase in July. “I would prefer a break and that it had been evaluated if the dose is having effects, that is, that they evaluated the impact of the climbs”, he points out.

The president of the ECB has already signaled that in September, when the next decision of the central bank takes place, they will not cut rates, admitting to maintaining or even raising them again. “They even admit to charging in September, which could be detrimental to the slowdown of the various economies”, warns the economist.

For Ricardo Ferraz, “there is something important that the ECB seems to be forgetting: despite looking at the members of the Euro Zone as a whole, we have to look and take into account the needs of each economy, countries are different from each other”, until because “there are members with a higher percentage of mortgage loans at a variable rate and they are more likely to be penalized, like Portugal”.

Peripheral countries are those with high rates, being states that “have already suffered a lot in the case of sovereign debt and ended up penalizing the euro zone”, points out the researcher. Thus, he defends that “there should be caution: the medicine is having an effect but we cannot abuse the dose”.

Supply chains, profits or wages. Where did the inflation come from?

In this way, there have been several factors influencing inflation. It was in the lack of definition and the end of the pandemic, in 2021, that prices began to rise, but in February 2022, with the Russian invasion of Ukraine, the increase accelerated. Furthermore, there was already a context in which the cost of money was low, with negative interest rates that have been progressively increased in an attempt to contain prices. There are also elements such as profit margins and expenses with the Recovery and Resilience Plan that affect inflation.

The measures applied by the ECB “always assumed that inflation was a demand problem and consumption capacity would have to be reduced to lower inflation”, but “it happens that it is very doubtful that this will be the case”, points out José Reis. “There was no significant increase in wages that would lead to people consuming more, requiring the ECB’s measure, so“ it is not plausible that it was the increase in demand that triggered an increase in prices ”, he says.

This increase will have, on the other hand, been “due to speculative attitudes on the part of those who sell and led to a very significant increase in profits and had other factors associated with value chains and the war that were not a matter of demand”, argues the economist.

This slowdown shows, even so, that if there was “a speculative attitude on the part of those who sell, this attitude was curbed”, and, on the other hand, “if there were problems in supply chains worldwide, and in energy prices” , these “stabilised.

With regard to the ECB’s action, even if it was not directed at the supply problems, the truth is that “if there was a reduction in the disposable income of families, where the price of housing counts, from the moment there was pressure ” it is also likely that demand has been affected.

The president of the ECB has already spoken of different “phases” of factors that contribute more to inflation. At the BCE Forum, in Sintra, Christine Lagarde highlighted the contribution of maintaining companies’ profit margins, pointing out that they were responsible for “two thirds of domestic inflation in 2022, whereas, in the previous 20 years, their average contribution was around of a third.”

However, Lagarde signaled that this situation is now dissipating and that the next phase of price control will focus on wages, whose impact on inflation is greater due to low productivity, he warned.

There are also other factors, such as the PRR, as the OECD has warned: these investments are “adding inflationary pressures”, thus potentially delaying the slowdown in inflation. As noted in the most recent Economic Outlook, “fiscal policy, including through the PRR, is supporting growth in 2023, but also increasing inflationary pressures, before becoming slightly restrictive in 2024″.

The professor at the University of Coimbra also admits that access to housing and other goods through credit was already easier, due to low or even negative interest rates.

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