Berlin, Frankfort The conflict with Russia and the rapidly rising energy prices are fueling concerns about a drastic increase in inflation: the chief economists of the twelve largest German banks and asset managers are raising their forecasts significantly, as a Handelsblatt survey shows.
On average, they expect an inflation rate of around five percent for 2022. They expect an average of 2.6 percent for 2023 – but see further risks. “Inflation will last longer and will probably solidify,” says Princeton economist Markus Brunnermeier in an interview with the Handelsblatt.
Experts also expect prices to rise significantly in the eurozone. The shadow council – a panel of experts on monetary policy moderated by the Handelsblatt – has doubled its forecast for 2022 to 4.6 percent. “This puts the ECB in a very uncomfortable position,” says Lars Feld, chief adviser to finance minister Christian Lindner.
On the one hand, the central bankers have to show that they are taking action against rising inflation. Calls for a rate hike are getting louder. At the same time, such a step would weigh on the economy in an already uncertain time.
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A new inflation indicator also suggests that rising prices will become a permanent phenomenon. The Handelsblatt, together with the University of Dortmund, has developed an early warning system for inflation based on millions of newspaper articles. The “I-Index” shows that the Ukraine war is likely to have a significant impact on the further development of inflation. A wage-price spiral is also becoming more likely.
The ECB is in a bind
For the ECB, rising inflation is an almost insoluble problem. Princeton economist Brunnermeier fears that if the ECB does not act, citizens’ inflation expectations could rise further. Then it would be “really expensive to stop inflation”. The economist demands that the central banks could counteract such a development by moving away from negative interest rates.
Other experts warn, however, that such a step would certainly trigger an economic crisis. The crisis is already weakening the economy, especially in countries that are heavily dependent on Russian gas. Rising interest rates could lead to renewed concerns about the sustainability of debt in individual euro countries.
Italy, for example, like Germany, covers large parts of its energy requirements through gas imports from Russia and has a particularly high national debt.
The chief economist at the International Banking Federation (IIF), Robin Brooks, fears that risk premiums in countries such as Italy and Spain could skyrocket. He recently warned on Twitter of a situation similar to that in March 2020 at the beginning of the pandemic.
At the time, ECB President Christine Lagarde made a clumsy remark that caused risk premiums for bonds from highly indebted countries to skyrocket. It was only by launching a particularly flexible bond purchase program that it was possible to curb it again in the crisis situation.
Given this experience, there is concern that something similar could happen again. An immediate rate hike is not to be expected anyway. The ECB leadership has repeatedly signaled that net bond purchases should be ended first. The head of the central bank, Christine Lagarde, may already announce this end at the ECB Council meeting on Thursday.
This is a difficult situation for the ECB, which is partly due to its own misjudgments. Central bankers initially underestimated inflation. Lagarde and her colleagues have repeatedly emphasized that the sharp rise in prices is due to special effects caused by the pandemic. For a long time, they stuck to their assessment that price developments would normalize over the course of 2022. However, there is currently no evidence of this.
The ECB had therefore recently signaled further steps to normalize monetary policy for March. The situation has now changed due to the war in Ukraine. If the central bank sticks to its very loose monetary policy, there is a risk that inflation will rise further, prompting unions to demand significantly higher wages to compensate.
The head of the ECB must once again master a difficult balancing act.
(Photo: Polaris/laif)
That could set in motion a wage-price spiral, of which only the beginnings have been discernible so far. Felix Hüfner, chief economist at UBS Germany, considers this to be the key question.
A wage-price spiral is conceivable, on the other hand, slowing economic growth could block higher wage agreements. Huefner sees “high upward risks” in energy prices.
Even before the outbreak of the Ukraine war, there was unprecedented uncertainty about how inflation would develop. This has now become even more pronounced. Andreas Rees, chief economist for Germany at Unicredit, expects inflation rates to have a five before the decimal point until well into the autumn.
Forecasts by economists vary widely
“Inflation rates below two percent are not expected to be reached again until summer 2023,” estimates Rees. However, it is currently difficult to assess whether this normalization will actually occur. “Basically, the uncertainty about the economic and inflation outlook is exceptionally high at the moment,” says Rees.
The adjusted inflation forecasts of the twelve banks and asset managers differ accordingly. MM Warburg expects an inflation rate of 5.7 percent for 2022, while H&A Global Investment forecasts only 3.3 percent.
The director of the Institute for Macroeconomics and Business Cycle Research (IMK), which is close to the union, Sebastian Dullien, even thinks a six before the decimal point is likely. “For such predictions, you don’t even have to assume that energy prices will remain at the heated current level like today,” says Dullien. For 2023, the projections range from 1.6 percent (UBS) to 3.8 percent (Hamburg Commercial Bank).
In America, the situation is different because the US is less closely linked via trade with Russia and largely covers its own energy needs. In addition, inflation in the USA is still significantly higher than in Europe and wages are rising much faster there.
US Federal Reserve Chairman Jerome Powell has already hinted that the Fed will raise interest rates by a quarter of a percentage point in March.
More: The I-Index – the new measurement of inflation