Inflation Unchecked... Dark Clouds Over European Economy This Year

UK Food Price Inflation Hits 17-Year High
Repeated Interest Rate Hikes Worsen Household Burden
Central Bank Debt Crisis Concerns...Government Bond Sell-Off

[Image source=Reuters Yonhap News]

[Asia Economy Reporter Lee Ji-eun] Despite the central banks' aggressive tightening policies, inflation in Europe is not easily controlled, raising concerns that the region may enter a stagflation phase where prices rise even amid an economic recession. This impact is expected to be particularly significant in Southern Europe, which has a fragile fiscal foundation.

According to Bloomberg on the 3rd (local time), the UK’s food price inflation rate in December reached 13.3%, marking the highest increase in 17 years since 2005. The December store price index, which reflects the year-on-year price increase of goods sold by retailers, recorded 7.3%. This is a slight decrease from the 7.4% recorded in November, which was the highest since the statistics began being compiled.

The red flag for inflation in the UK economy is the result of a vicious cycle caused by the Bank of England (BOE), the UK’s central bank, raising interest rates nine times to curb inflation triggered by the Russia-Ukraine war, which in turn has weakened household purchasing power. Major foreign media explained that "the successive BOE rate hikes have reduced consumers' purchasing power and increased interest payments on mortgages, damaging household finances," and that high inflation has affected real income, consumption, and industrial production.

The tight labor market environment, worsened by a sharp decline in the workforce due to the COVID-19 pandemic, also intensified inflation. As labor demand exceeded supply, wages rose, increasing the burden on companies and contributing to upward pressure on prices. BOE’s chief economist Charlie Bean stated, "Even excluding the factor of the Ukraine war, inflation in the UK is likely to remain high due to the sharp decline in the workforce since COVID-19."

Experts predict that based on these two indicators, inflation, which peaked last year, will ease this year, but the overall upward trend in prices is expected to continue for some time. A report from Consensus Economics forecasted that the US GDP will grow by 0.25% this year, while the UK’s GDP is expected to shrink by 1%.

The economic outlook for the Eurozone is also bleak. Like the UK, addressing the energy crisis and resolving inflation is challenging. Particularly, in Southern European countries such as Italy, which suffer from chronic fiscal difficulties, there are concerns that the European Central Bank’s (ECB) interest rate hikes could trigger a debt crisis. Major foreign media explained that as the ECB raised benchmark interest rates, borrowing costs increased for Southern European countries, and investors are selling off government bonds of these countries considering their fiscal troubles.

As the sell-off continues, bond yields in these countries have soared. The spread between Italy’s 10-year government bond yield and Germany’s 10-year bond yield, considered a safe asset, stood at 2.14 percentage points as of the 5th. In addition, bond yields in other Southern European countries facing fiscal difficulties, such as Spain and Greece, are also rising sharply.

However, the abnormal weather conditions that have appeared this year are seen as a ray of hope for the gloomy European economy. On New Year’s Day, temperatures in southwestern France rose to 25 degrees Celsius, and the central Spanish city of Bilbao recorded 25.1 degrees Celsius on the same day, maintaining levels similar to the average summer temperature in July last year. Due to the warm winter, heating demand decreased, leading to a drop in energy prices. On the 4th, the Dutch TTF, a European gas price benchmark, saw the price for February delivery gas fall 11% from the previous trading day to 64.4 euros per 1 MWh (megawatt-hour), the lowest level since February 22, two days before the Ukraine war began.

Although energy prices are falling, prices in the food and service sectors are still rising, leading some to believe it is too early to be optimistic. Major foreign media explained, "Price pressures in services and food have hardly changed and are even continuing to increase," adding, "Spain’s core inflation excluding energy and food has risen, and Germany’s service prices are on an upward trend."

This content was produced with the assistance of AI translation services.