Eurozone Inflation Now Principally Demand-Driven, ECB’s Schnabel Says

29 March 2023

By Xavier D’Arcy – WASHINGTON, D.C. (Econostream) – Inflation in the euro area is now being driven principally by domestic demand rather than supply-side factors, European Central Bank Executive Board member Isabel Schnabel said on Wednesday.

Speaking at the NABE Economic Policy Conference, Schnabel said that core inflation was proving to be stickier than headline inflation, causing headaches for central bankers.

There had been a ‘rotation’ in euro area inflation ‘from supply side factors to demand side factors’, she said. Supply side factors were ‘dropping out […] but then on the other hand […] the demand side factors are now kicking in.’

This demand side-driven inflation ‘is something that central banks know how to deal with normally, but also, these may be things that are more self-sustained, that is not simply going to disappear so it requires a monetary policy reaction’, she said.

Core inflation ‘has stabilised in the US but it's still moving upwards in the euro area’, she said. ‘In general I think the message is that core inflation is proving to be much stickier than headline inflation… and of course, this causes some headaches’ for central bankers, she said.

In her view, it was possible falling energy prices would only have a limited impact on core inflation, despite having been a big contributor to rising underlying price pressures. The energy shock ‘really moved very quickly in into core inflation’, she said. ‘And now that the interesting question is, is it going to drop out at the same speed? My suspicion is that it is not the case […] and it's not even clear whether it's going to be completely symmetric in the sense that everything is even going to drop out at all.’

The lack of pass-through of energy prices to core inflation was ‘one of the factors that explains why core inflation is more persistent’, she said.

Regarding recent financial instability, the situation was less acute in the euro area compared to the US, in her view: ‘It looks like we have a somewhat smaller problem than we're seeing in the US… at least so far, it looks that as if our banks were actually quite resilient.’

‘I would say at the moment from the financial stability side, this all looks resilient’, she said.

The implications of recent developments for monetary policy were uncertain, though likely to be disinflationary, she argued. She expected ‘the effects will be somewhat smaller than in the US, but nevertheless, you cannot exclude that what is happening now has an impact on credit conditions, on credit supply, and so directionally it's very clear that this would have a disinflationary effect, which we would need to take into account in our decisions.’

She said it was ‘completely open for now how big that effect is going to be.’

Labour markets ‘continue to be very tight… at the same time, a real wages have come down […] so it's maybe not surprising that this leads to an upward pressure on wage growth’, she said. On the other hand, ‘the rise in profit margins was a major driver in inflationary developments’ in the euro area.

The post-pandemic economic circumstances ‘were such that it became very easy for [firms to increase prices]’, she said. The rise in profits showed that ‘the brunt of that burden is being borne by the workers, and I'm not surprised that not everybody's happy about that’, she said.

She said that the latest data ‘would suggest that further declines in how house prices should be likely, and it also shows that the decline should be stronger in the US than in the euro area.’