Europe - soaring energy prices’ impact on inflation more a concern in UK than the euro area

Europe - soaring energy prices’ impact on inflation more a concern in UK than the euro area   

• EUR & GBP: The pick-up in euro area and UK inflation has proved to be faster, larger and shows signs of being more persistent than previously expected. The key question now is whether this can morph into more persistent inflation, or whether it reverts into transitory disinflation in the years ahead. This will have implications for ECB and BoE monetary policy. For now, Citi analysts lean towards the latter view.               

• EUR & GBP: Energy pass-through: much more to come – euro zone gas HICP has increased by 15.1% YY in August, electricity HICP by 9.4%, both up from negative inflation rates in 2020. Overall housing energy inflation is up 12.5% YY, contributing 0.7pp to headline and there remains plenty of pass-through yet to occur at the euro area aggregate level from the recent rise in natural gas prices. Citi analysts tentatively estimate euro zone electricity and gas prices are likely to add an extra 0.6pp to headline inflation over the next five prints. For the medium-term outlook, past evidence suggests that in the aftermath of large price hikes in euro area, gas and electricity retail price inflation tend to stay elevated for at least one year after the shock. This suggests energy inflation is likely to stay elevated throughout 2022 and at least 1H 2023. In the UK, wholesale prices are expected to increase by roughly 45% and thus an overall increase in the energy price cap of 18-19%. A 18-19% jump would imply a 0.6pp contribution to MoM CPI inflation in April 2022, according to Citi analysts.

• EUR & GBP: Will wages react? The ability of employees to “pass up” higher CPI inflation to their employers remains feeble in UK and euro zone. Recent data suggests wage inflation in the euro zone keeps weakening as euro area negotiated wage growth still trends downwards. It would take wage demands exceeding 6% to have a chance at causing inflation. Even the latest labor union demands in Germany - 5.2% in the booming construction sector and 5% for public sector workers at the level of the 16 states, do not fulfil that criterion. In the UK, wage pressures are not yet acute and while inflation is now accelerating sharply, the proportion of employees planning to ask their employers for a pay rise remains at near record lows, according to the BoE inflation attitudes survey.

• EUR & GBP: Expectations’ shift - only a meaningful upward drift in inflation expectations carries risks of an upward wage-price ‘spiral’. Citi analysts see risks here greater in UK than the euro zone, where rising inflation expectations should still be seen as welcome after years of undershooting. But upside risks to inflation expectations are growing in UK where the latest Citi/YouGov inflation tracker shows households expect inflation at 3.8% per year in 5-10 years, well above the long-run average of 3.2%. In the euro area, the EU Commission’s one-year ahead inflation tracker also points to rising expectations, but its persistence is less clear. So while in UK, high inflation expectations are becoming uncomfortable, in the euro area they should still be welcome.  

Data releases Friday - German ifo more resilient than expected

• EUR: The German Ifo Business Climate for September comes in at 98.8 versus (Consensus 99.0, Citi 99.5, Prior: 99.6) with the expectations component up at 97.3 versus (Consensus 96.5, Citi 97.0, Prior: 97.8) but the Current assessment lower at 100.4 versus (Consensus 101.8, Citi 102.0, Prior: 101.4). The most important component of the Ifo index (expectations), which leads business investment by one quarter, declines by less than Citi analysts and consensus expects. Amid supply shortages and rising energy prices as well as growth worries about Germany’s largest single-country trading partner China, this resilience appears remarkable. Domestic sector also appears fine - in contrast to the recent PMIs – the domestic-oriented sectors all report virtually unchanged (retail trade) or improving sentiment (services , construction), though manufacturing sentiment cools further from high levels. 

Week Ahead  

• USD: Fed speak - Evans and Governor Brainard speak at Annual NABE conference, Williams discusses the economic outlook, Chair Powell and Treasury Secretary Yellen appear before senate banking panel, Bostic discusses economic outlook, Bullard discusses U.S. economy and monetary policy, Williams discusses Fed’s pandemic response, Harker discusses the economic outlook, Mester discusses inflation and employment.  

• USD: US August Personal Income – Citi: 0.3%, median: 0.2%, prior: 1.1%; Personal Spending – Citi: 0.4%, median: 0.6%, prior: 0.3%; Core PCE MoM – Citi: 0.3%, median: 0.2%, prior: 0.3%; Core PCE YoY – Citi: 3.6%, median: 3.5%, prior: 3.6% - despite a soft 0.10% increase in core CPI in August, Citi analysts expect a much stronger 0.26% increase in core PCE inflation leaving the Y/Y measure elevated, rising closer to 4.0% by year-end. 

• USD: US September ISM Manufacturing – Citi: 58.9, median: 59.5, prior: 59.9 - ISM manufacturing should fall to 58.9 in September from 59.9 in August as supply issues constrain production and employment. In particular, the employment component is likely to remain in contractionary territory, in line with persistent labor shortages.

• EUR: Euro area HICP Inflation, September Flash – Citi: 3.2% YY, prior: 3.0% YY - the sizable increase in electricity and gas prices (refer above to – “Europe - soaring energy prices’ impact on inflation more a concern in UK than the euro area”) will contribute to push headline inflation again higher in September, adding around 0.2pp to the YY rate. Core inflation should also edge higher still, from 1.6% to 1.7% YY. Citi analysts still pencil in further above-trend growth in core goods prices, reflecting supply chain disruptions and strong demand for durable goods and see euro area inflation peaking in November probably above the team’s current forecast of 3.5% YY.

• AUD: Australia August Retail Trade Citi forecast; -3.0%, Previous; -2.7% - the August retail trade data will bear the full impact of Greater Sydney’s lockdown and the return of lockdown conditions in Melbourne. August has also recorded a large drop in employment and reductions in take-home pay will weigh on discretionary spending. In total, Citi analysts forecast a 3.0% decline in retail trade in the month, the lowest reading since April 2020.

• CNH: China Manufacturing PMI September: Citi 50.2, Prior -- 50.1 – China’s official manufacturing PMI might stay above the 50 mark in Sep-21 due to seasonality. Blast furnace operating rates by steel mills have weakened somewhat nationwide due to tighter environmental policy, but impact of the flooding in some parts of China should have diminished. Meanwhile, new orders could hold up if export orders are supported by production disruptions by the pandemic outside China. Price indices though are likely to remain elevated due to tight supply constraints.   ​​​​​​

This is an extract from the Daily Currency Update, dated September 27, 2021. Please approach a Citigold Relationship Manager if you would like more information. For the latest updated CitiFX house views and strategy (updated every Monday) please click here - 

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