Charting the extremes of eurozone inflation dispersion

2 min read 7 Jul 22

With eurozone inflation currently at 8.1%, setting monetary policy for 19 member states is no mean feat, especially as the dispersion of eurozone HICP [Harmonised Index of Consumer Prices] inflation rates reaches 14.5% – the widest divergence ever. This interactive chart looks at the extent to which we’ve stepped out of the norm in the context of historical divergence.

The euro area originally comprised 11 member states when the currency was first introduced in 1999, and this has since grown to 19 countries.

As the chart demonstrates, since its inception, inflation in the euro area has been reasonably well-behaved. Since 2008, European Central Bank (ECB) policy setting has been supported by low inflation, low interest rates and modest divergences across the zone – up until now. Since the arrival of Covid-19, divergences have been steadily increasing and accelerating. 

“The challenge for the ECB is to find a single monetary policy that is simultaneously appropriate for those economies at the higher extremes of the inflation dispersion…and for those countries closer to, or below, median levels of inflation.”  
 

With the sudden arrival of high inflation we are now seeing the greatest level of dispersion in the eurozone (20.1% in Estonia vs. 5.6% in Malta) than at any point in its history. The challenge for the ECB is in applying a one-size-fits-all monetary policy to 19 very different economies that are at different points in the inflationary cycle, as the chart shows.

“The challenge for the ECB is to find a single monetary policy that is simultaneously appropriate for those economies at the higher extremes of the inflation dispersion, notably the Baltic States, and for those countries closer to, or below, median levels of inflation,” says David Lloyd, Deputy CIO of Public Fixed Income at M&G Investments.

In a period where global markets were recovering quite strongly, the pandemic programme and the quantitative easing (QE) purchases attached to it may have arguably extended too far, leaving the ECB in an existential policy quandary of having to move from quantitative easing towards quantitative tightening, but certainly towards higher interest rates and having to do it in the least disruptive manner possible for markets.

Adding to the ECB’s woes has been the steady widening of bond spreads between Eurozone countries. The ‘fragmentation’ has reached levels that has prompted concerns of a nascent sovereign crisis, and seen the ECB urgently seek measures to address the dispersion of government bond yields. The strength and nature of their response will become apparent over the next few months.

You can use the interactive chart to see the inflationary highs and lows and the member state they correspond to, as well as the eurozone average since 1999. 

The value of investments will fluctuate, which will cause prices to fall as well as rise and investors may not get back the original amount they invested. Past performance is not a guide to future performance. The views expressed in this document should not be taken as a recommendation, advice or forecast.

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