The major focus this week has been all about US inflation, even more so after the hotter-than-expected September CPI report. And while markets are busy trying to digest what that might mean for the Fed outlook, perhaps we should also be paying some attention across the Atlantic to what looks to be a trickier inflation problem in Europe.
Euro area headline annual inflation climbed to 3.8% in September, with core annual inflation nudging back higher to 2.5%. The ECB is facing a tough task in trying to get inflation back to its 2% target, but there is perhaps a bigger problem to contend with. And that is the fact that unlike the Fed, the ECB has to contend with more than a handful of economies that aren't necessarily moving at the same speed.
Just imagine you're needing to adjust the air conditioning for an entire office building but you only have one thermostat to work with. Some rooms are already freezing cold while others are still unbearably warm. So, how do you go about in finding a solution? In simple terms, that is pretty much the ECB's dilemma on the inflation battle.
We are seeing the likes of Spain face up against strong inflation pressures as core annual inflation there climbs above 3% in September. Meanwhile, France continues to struggle with a much weaker growth backdrop even as core annual inflation remains much lower at 1.5%. Both countries are facing very different economic challenges, yet both have to live with the same interest rate policy.
For the ECB, that creates a bit of an uncomfortable situation. If policymakers decide to raise key interest rates to tackle inflation, it risks putting even more pressure on struggling economies. But if policymakers decide to hold back on tightening policy instead, they risk letting inflation run even more rampant in countries where price pressures are already proving to be rather persistent.
Damned if you do, damned if you don't.
Now, that is not to say that the Fed has it easy in terms of deciding on monetary policy in order to defeat the inflation monster. But at least it only needs to set interest rates for one national economy, rather than trying to balance the needs of 21 different countries that are also sharing a single currency.
And therein lies the bigger risk for Europe in general. The ECB might eventually succeed in bringing inflation back down to its target, but at what cost? How much economic damage will policymakers have to tolerate in getting there? Higher interest rates might be the right cure for inflation, but it isn't something that every European economy can afford to take in.
This article was written by Justin Low at investinglive.com.from Investinglive RSS Breaking education Feed https://ift.tt/uFPcE7h
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