Highest inflation since the launch of the Euro
The January euro-area inflation was a shocker, with the CPI the highest ever since the launch of the Euro. Energy was the biggest driver, but the core CPI surprised to the upside as well, signaling the issue is far from "temporary".
The January euro-area inflation was a shocker, with the CPI climbing above 5%, the highest ever since the launch of the Euro. Energy was the biggest driver, but the core CPI surprised to the upside as well (see chart) signaling the issue is far from “temporary”. While finally starting to acknowledge the problem, the ECB is seriously behind the curve with funding rates still below zero and € 80 bil of bonds of monthly purchases. The problem is that to counter inflation the ECB should tighten monetary conditions. Something they cannot do. The simple and yet dramatic problem is that member states have very large stocks of debt and large fiscal deficits and since 2012 the ECB has been the sole lender willing to fund debt in quantity and at rates that no other buyer would be willing to bear. Should the ECB stop purchasing bonds and suppressing rates a massive debt crisis would rapidly ensue. Italy is looking especially at risk with a debt to Gdp ratio close to 160% and decades-old structural economic weakness. After two years of pandemic, fiscal deficits in the high single digit and ever growing public current spending have become a fact of life for Italy. There is no political room for fiscal tightening and Italian government debt will continue to expand. It must be monetized either by a reformed ECB or by a reinstated Bank of Italy. History, context and political game theory suggest the latter. The rise of inflation has changed the context and it is clear that the eurozone is hurling towards some restructuring; either a wholesale change of rules to enable debt cross-collateralization among member states or the return of some countries to monetary sovereignty. A eurozone crisis is a grossly underestimated geopolitical risk as financial markets seem to be blissfully unaware. The common rationale is that Italy’s €10 trillion of private wealth will eventually make good on the debt is flawed as there is no political willingness to activate that solution. Italians will indeed end up canceling out their debt with their savings but it will be through the currency’s debasement, most likely a new Lira.
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