|Q: Inflation has been rising rapidly in the U.K. and the Eurozone just as it has in the U.S. What is driving the acceleration in those places? Are the factors at play different than in the U.S.?
Paul Hannon: The big driver of faster inflation in Europe is energy. The real acceleration in consumer prices came later than in the U.S., and can be dated to the buildup of Russian troops at Ukraine’s borders back in October. It’s not that an invasion seemed to be the most likely outcome at that time, but there was clearly a growing risk that Russia’s exports of natural gas and oil might suffer some form of interruption, and energy prices really began to rise sharply from then on. Another difference is that strong consumer demand is less of a driver – that’s mainly a U.S. story linked in part to the scale of the fiscal stimulus and the strength of the jobs market.
Q: How are policy makers in the U.K. and the Eurozone tackling inflation? Are forecasters expecting a recession in the near future?
Paul Hannon: There is a split between Europe’s leading central banks in their response to rising inflation, which is mainly to do with what’s happened to prices over the past decade or so. The Bank of England first raised its key interest rate in December, ahead of the Fed, while the European Central Bank doesn’t seem likely to move until the final three months of this year. Now, the U.K. has long had higher inflation than the eurozone, and created its own, special supply shock by deciding to leave the European Union in 2016, so British policy makers see a greater risk of a wage-price spiral. In the eurozone, there is a history of very low inflation that goes back to the eurozone’s debt crisis. The really challenging thing for both central banks is that the threat of a recession is very real, with big hits to consumer and business confidence from a European war that could yet spill beyond its current borders, while the squeeze on household incomes is becoming tighter by the month.
Q: How could rising prices affect Europe’s efforts to wean itself off of Russian gas as a consequence of Russia’s invasion of Ukraine?
Paul Hannon: There’s no doubt that the economic costs of a sudden end to purchases of Russian oil and gas are a major factor in the debate over how far Europe can go in sanctioning Vladimir Putin. That’s particularly true in Germany, which consumes a lot of Russian gas, and where there is a very charged debate over the economic costs of turning the taps off. Nobody doubts that would lead to a recession, but the question is, how severe would it be? Economists tend to think not that severe–say a contraction of 2 % or 3 % this year–but politicians don’t appear to be convinced that the costs would be that contained. This is not a debate that central bankers want to get involved in, but it’s pretty clear that ending purchases this year would make their jobs more difficult, since growth would slow more sharply than they now expect, while inflation would likely accelerate more rapidly.