Inflation: the last few miles

Everywhere, inflation is on the ebb. In the United States, it fell back to 4% in May, having reached 9% in June 2022. In the eurozone, after peaking at over 10% in October 2022, preliminary estimates for June suggest it has dropped to 5.5%.

So, does this mean the battle is over? Sadly, no.

Firstly, although the trend for headline inflation is reassuring, this is much less true of “underlying” inflation, which is adjusted for the most volatile elements. This reached 5.3% in May in the United States and 5.4% in June (preliminary estimate) in the eurozone. In other words, it was higher than overall inflation in the United States, and at almost the same level in the eurozone. In both cases, the downward trajectory was only slight – there was even a small rebound in the eurozone.

The difference between the two types of inflation can mainly be attributed to the fall in commodity prices following their surge as a result of the war in Ukraine. European oil futures, for example, have fallen from over USD 100 a barrel in March 2022 to an average of USD 80 since the start of the year, and European natural gas has wiped out the price gains it made at the outbreak of the war.

But if core inflation is falling less rapidly than headline inflation, this is not solely due to the fall in commodity prices, which only benefits the latter. It is also because there are powerful factors driving underlying inflation, which Christine Lagarde, in her recent speech at the central bankers’ meeting in Sintra, described as relatively long-lasting and therefore worrying.

The first factor is wage inflation. In the United States, the average hourly wage rose by 4.3% in May. Granted, wage growth has fallen from a peak of almost 6% in March 2022, but it has hardly shown any downward movement for several months. In the eurozone, the European Central Bank expects to see wages rise by 14% by the end of 2025, or almost 5% per annum. While it may be good news for employees, this rarely attained level is causing concern in that there is a great deal of inertia, particularly in Europe where wage negotiations are often annual, creating the conditions for the possibility of lasting inflation.

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