Inflation: Why inflation in America is falling more than in the euro area

According to a survey by the European Central Bank (ECB), consumer inflation expectations in the euro area have fallen.

In November, respondents expected an inflation rate of 5 percent over a 12-month horizon, as the ECB announced on Thursday.

In the month before, the expectation was still 5.4 percent.

Christian Siedenbiedel

Editor in Business.

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"But it's too early to give the all-clear," commented Jörg Krämer, chief economist at Commerzbank: "Expectations are still well over 2 percent." According to its economic report published on Thursday, the ECB itself expects an average of 6 percent for the current year. 3 percent inflation, after 8.4 percent last year.

It is worth noting that while the inflation rate in the United States fell to 6.5 percent in December, as announced on Thursday, it was still 9.2 percent in the euro area.

That was also a decline - but by no means to comparable values.

Different causes of inflation

In its economic report, the ECB dedicates itself in detail to the differences in the development of inflation in the United States and the euro area.

A more recent development is striking: in the euro area, the contribution of demand to core inflation – that is inflation without strongly fluctuating prices such as those for energy and food – has been higher than that of supply for a few months now.

This is remarkable because for a long time inflation in the euro area, unlike in America, was thought to be predominantly supply-driven.

"Consistent with the weaker recovery over the past year, demand as a driver of core inflation in the euro area has also grown correspondingly more slowly and later than in the United States," the report said.

The inflation rate in America had risen earlier than in the euro area, up to 9.1 percent in June last year - but then fell again more quickly, down to 6.5 percent in December.

In the euro area, inflation rose to 10.6 percent up until October last year, before falling slightly in November and December to 9.2 percent most recently.

"Although inflation dynamics started earlier in the US, higher values ​​have been reported in the euro area since July 2022," the report says.

Energy and food prices in particular contributed more to the increase in inflation in the euro area than in America: the increase in energy prices alone accounted for 38 percent of the price increase in the euro area in November - in the United States only 14 percent.

For a long time, the Americans benefited from the fact that the euro was weak and the dollar strong.

This pushed up the prices of imported goods such as energy more in the euro area than in the United States.

The report speaks of exchange rate and terms of trade effects.”

In the meantime, however, the development of exchange rates has reversed to some extent.

Differently affected by the Ukraine war

"A major reason for the stronger increase in energy prices in the euro countries are the significantly higher natural gas prices," says the report.

Among other things, these are a consequence of the great importance that Russian gas supplies had for the euro area before the war against Ukraine.

Core inflation, i.e. inflation excluding energy and food, was 5 percent in the euro area in November, and still 6 percent in the United States (using slightly different measurement methods).

However, this rate moved sideways in the euro zone in November, while it declined slightly in America.

In December it even fell from 6 to 5.7 percent in the United States - in the euro area, on the other hand, it rose from 5 to 5.2 percent.

ECB President Christine Lagarde recently described the differences as follows: First, energy is the key driver of inflation in Europe.

The prices for electricity, gas and fuel made up 60 percent of the inflation drivers in the euro area.

"In America, it's half of that." Second, wages in America have risen significantly more.

The wage increase there is 5 to 7 percent, in the euro area the collective wages have so far increased less.

There are also differences with regard to the question of whether inflation is driven more by supply or demand.

"Our inflation is very supply-driven," Lagarde said.

Supply bottlenecks and supply chain disruptions would have caused prices to rise.

"In America, inflation is more demand-driven."

This could have consequences for the question of how quickly inflation will come down again.

"In the United States we are in a cyclical downturn, a classic cycle in which demand is now falling," says economist Cyrus de la Rubia of Hamburg Commercial Bank.

"In Europe, it's mainly a downturn triggered by supply shocks - supply chains, availability of raw materials." That's driving prices, or it's taking longer for them to go down.

differences in monetary policy

However, the economist Volker Wieland had already brought up the possibility that the earlier intervention by the American Federal Reserve could have contributed to the fact that inflation there is falling again more quickly than was the case at the ECB.

This may already have had an impact on inflation expectations.

For the future, the ECB economic report expects a reversal of the situation at some point: in the short term, inflation in the euro area will remain at a higher level than in the United States, since the euro countries are more severely affected by the energy price shocks in connection with the Ukraine war.

However, professional forecasters assume that in two years the inflation rate in the United States could possibly even be slightly higher than in the euro area.