Core inflation in Europe should take longer to subside than in the US, says Capital Economics

The perceived contrast between consumer inflation (CPI, its acronym in English) in the United States and Europe, which was evidenced last week should remain in 2023. The projection was made in a report by Capital Economics. In October, the annualized CPI in the US reached 7.7% (compared to 8.2% in September), while the index in the Euro Area reached 10.6% (above the 9.9% of a month before).

According to the economic research firm, although core inflation looks set to fall in all developed markets, the energy crisis and tighter labor markets in Europe are among the reasons why the speed of fall in inflation in the continent tends to be slower.

The company pays more attention to the behavior of core inflation. In the euro area, the index excluding energy and food was still strong in October, reaching 5%, with inflation across all major product groups close to or at record levels. On the other hand, the assessment is that core inflation in the US (6.3%) has already peaked.

According to Simon MacAdam, senior economist at Capital Economics, there are three reasons why core inflation tends to fall more slowly in Europe than in the US. The first is that while goods shortages have eased globally, they remain acute across many sectors in Europe, suggesting that pressures on goods prices will remain more resilient in the coming months.

“According to the latest surveys, shortages still afflict 54% of industrial companies in the UK, and almost all manufacturing sectors in the Eurozone are suffering from more widespread shortages now than they ever experienced before the pandemic,” MacAdam said in the report.

“Combined with much higher energy prices, a higher prevalence of scarcity may explain why pressures on consumer goods prices have been much stronger in Europe than in the US,” he explained.

The second reason is that labor markets seem tighter on the European continent than in the US. “Hourly earnings growth has already slowed in the US, while growth in regular wages in the UK has picked up. And in the Eurozone, Indeed’s salary tracker suggests that salary growth offered to new hires has skyrocketed from less than 2% annually to more than 5% so far this year.

According to him, it is true that job vacancy rates and companies’ hiring intentions have decreased both in the United States and in Europe. But the shortage of workers is apparently worse in the latter and that means employers in the Eurozone and the UK may be more reluctant than their US counterparts to cut back on hiring or lay off workers when economies weaken in 2023.

The third factor is that there are a number of quirks in the US CPI data that the UK and Eurozone do not share, such as health insurance and used car prices, for example.

“The most significant difference between the US and Europe is that rents are a big driver of inflation in the US but barely move the needle in Europe. So, given that timely private sector rent measures have sharply weakened in the US, this should be a major drag on core inflation in that country that Europe will not replicate,” he said.

As a result, Capital Economics believes that core inflation in Europe may fall in 2023, as will happen in the US, but that this should only happen towards the end of next year – for the UK, this will not happen sooner. from 2024 .

“Higher core inflation in Europe is one of the reasons we expect the Bank of England and ECB to move to rate cuts later than the Fed, which we think will start cutting rates as early as the third quarter of the year. what’s to come,” he predicted.

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