Europe less at risk of inflation and rate fears: analysts

PARIS – Investors are watching inflation carefully, worried that a boiling over of prices will ruin the expected strong pandemic recovery although analysts believe Europe faces much less of a risk than the United States.

Fears that US President Joe Biden’s US$1.9 trillion (RM7.7 trillion) stimulus plan – which was passed by the House of Representatives yesterday – will stoke up the economy too much have unnerved investors in recent weeks.

A rise in yields on 10-year US Treasury bonds – a key indicator of expectations – shows the markets believe prices are set to rise much more sharply than last year’s gain of 1.4%, which could force the US Federal Reserve to hike interest rates earlier than it says it plans to do.

Bond yields have risen elsewhere too, with 10-year French government bonds turning positive last Thursday for the first time in months while the benchmark 10-year German Bund has also risen although it remains negative.

European inflation data for January showed a jump in prices of 0.9% compared to a -0.3% reading in December, as increased costs of raw materials fed through into services and industrial goods.

After having slowed considerably in 2020, inflation is expected to rise this year in Europe as the economy picks up following the relaxation of measures to slow the spread of the Covid-19 pandemic.

But it is not so much a spike in inflation that worries investors but that the Fed would raise interest rates faster than it has communicated.

Federal Reserve chairman Jerome Powell pledged last Tuesday that the US central bank will keep benchmark lending rates low until the economy is at full employment and inflation has risen consistently above its 2.0% target.

But bond yields continued to rise, indicating investor concern about a rise in interest rates that would make borrowing and investment more expensive and slow the economy.

However, many analysts are sceptical that Biden’s stimulus programme will spark considerable inflation.

“It isn’t clear that Biden’s recovery plan will create lots of inflation,” said Xavier Ragot, president of the French Economic Observatory think tank.

For the European Union (EU), there is no likelihood that its pandemic recovery programme would, he believes.

“The amounts of the European recovery plans pose absolutely no inflationary risk,” he said.

The European Commission’s recovery programme is worth €750 billion (RM3.67 trillion), with several EU members also having their own national programmes.

“We have a European recovery programme... considerably less strong, and a loss of growth that is much greater, so there aren’t the same risks of overheating as in the United States,” said Fabien Tripier, an economist at CEPII, a Paris-based research centre on the world economy.

The US economy shrank 3.5% last year while the drop for the eurozone was nearly double that.

There is “no risk of overheating or a sustained rise in inflation” in the eurozone, Banque de France governor Francois Villeroy de Galhau insisted this past week.

Ragot also does not believe that if the Fed is pushed by the markets into raising rates that the European Central Bank (ECB) would be forced to follow suit.

“It doesn’t work like that in macroeconomics,” he said, noting that the monetary policy of the Fed and ECB had diverged considerably at the start of the last decade.

“With loose financial conditions still necessary to support the economy, the ECB is unlikely to react to the coming inflation overshoot,” said Capital Economics economist Jack Allen-Reynolds.

de Galhau – whose position as head of the French central bank also means that he sits on the ECB’s Governing Council – said the central bank wants to “maintain favourable financing conditions”.

For Fabien Tripier, the ECB needs to send “a strong signal” to the markets against the idea that “just because inflation hits 1.5% or 2.2%, speculation it will hike rates should begin.”

The ECB issued a reassuring message last Friday as executive board member Isabel Schnabel said it could broaden its support for the economy in case of a sharp rise in interest rates. – AFP, February 28, 2021