Annual inflation in the UK climbed from 9.9% in August to 10.1% in September, returning to its highest level seen in 40 years, which had already been reached in July. For reference, the UK's average annual inflation, between the years 2000 and 2019, was 2%. The story in the Euro Zone is similar: annual inflation rose to 9.9% (from 9.1% in August), reaching its highest value since it began to be measured, in 1991. Energy prices are a key part of the current inflation problem, and as winter approaches, higher energy bills for both consumers and companies are a source of worry.
In both cases, food and energy had the greatest impact on price increases, due in part to Russia's invasion of Ukraine and the approaching winter. However, the rise in prices is widespread and goes beyond these two volatile categories: core inflation, which excludes food and energy due to its volatility, increased in both economies. In the case of the United Kingdom, it increased from 6.3% to 6.5%; and in the Euro Zone, it increased from 4.3% to 4.8%—for reference, in the US it is currently 6.6%. This indicates that the rise in prices is widespread, going beyond the increases in food and energy.
Before winter begins, Europe has taken certain measures to deal with fuel shortages. For example, its gas reserves are approximately 90% full, 15 percentage points higher than they were on the same date in 2021, while certain officials have proposed putting a cap on the prices of certain fuels and softening increases. While this may contain prices through the winter, difficulties will persist until the war comes to an end.
For their part, the Bank of England and the European Central Bank have signaled that interest rate hikes to combat high inflation will continue. Against this measure are those who argue that this will accentuate the expected slowdown in the economy for next year. On the other hand, as in the US, unemployment rates in the UK and the European Union are at historically low levels, supporting the thesis that there is still ample room for central banks to apply a more contractionary monetary policy. The unemployment rate in the United Kingdom decreased by 1 percentage point to 3.5% in August, its lowest value since 1974. For its part, the unemployment rate in the Eurozone remained at 6.6% in August, its lowest value on record.
So far this year, both the euro and the pound have depreciated considerably against the dollar, largely due to the slowdown that is expected for both economies in the future, and also as a consequence of higher rates in the US. The pound also suffered recently amid concerns of higher levels of public debt, but the government has already put an end to the tax cuts that triggered the market’s concerns.
Restrictive monetary policies and the worse outlook for 2023 have put pressure on the rates that European governments are required to pay for their debt. This is mainly worrying for highly indebted Eurozone countries, such as Italy or Greece. Indeed, the European Central Bank has already announced measures to soften the impact of rate hikes on Italy's fiscal accounts, and the Bank of England has just finalized an emergency government bond purchase program.
In the future, although different projections do not anticipate a recession in Europe, a slowdown is expected. For 2022, the IMF projects GDP growth of 3.2% in Europe, which would decrease to 0.6% in 2023. Thus, the task of the central banks will not be easy, since they will have to combat high inflation with the latent risk of deepening the economic slowdown in 2023. The measures that will be taken in the following weeks to face a winter with high energy prices and higher rates will be essential to project where inflation is headed. In addition, although the markets anticipate future increases in monetary policy rates in the region, it is not clear whether government bond purchase programs will be resumed or deepened, especially in the United Kingdom and Italy. Something could break, forcing central banks into the markets once again.
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