The near-term fortunes of the euro's purchasing power is looking a lot that of the dollar. From Bloomberg:
Inflation in the dozen nations sharing the euro accelerated in September to the fastest pace in more than a year after oil prices surged to a record.
Consumer prices rose 2.5 percent from a year earlier, after increasing 2.2 percent in August, Eurostat, the European Union's Luxembourg-based statistics office, said today. That was the biggest annual gain since May 2004 and topped the 2.4 percent median estimate of 32 economists surveyed by Bloomberg. A separate report from the Brussels-based European Commission showed consumers and executives anticipate rising prices.
One difference between the U.S. and Eurozone, of course, is that the European Central Bank has an explicit inflation target and the Federal Reserve does not.
A 53 percent increase in the price of crude oil this year pushed inflation beyond the European Central Bank's target of just below 2 percent for eight months. That's prompting ECB council members including Yves Mersch and Axel Weber to say the Frankfurt- based bank is concerned about prices, suggesting its next shift on interest rates may be an increase.
Nonetheless:
The ECB's governing council next sets its benchmark interest rate Oct. 6 and 29 economists surveyed by Bloomberg are unanimous in expecting it to leave it unchanged.
One reason for that may be that the data is not clearly speaking to a pick up in the inflation trend:
The euro-area's so-called core rate of inflation, which excludes energy and food prices, held at 1.3 percent in August, the lowest since February 2001. Eurostat will publish a breakdown of September's data on Oct. 18.
Another reason might be that inflation expectations appear to have stabilized. From Reuters:
ECB policymakers regularly cite the low level of expected inflation as a reason not to raise interest rates...
The break-even rate [one commonly used measure of market inflation expectations] is the difference in yields between inflation-indexed and normal government bonds. Very roughly it represents the average annual inflation rate that bondholders expect over the life of a bond.
The 10-year BEIR rose steadily from a trough of 1.7 percent in June 2003 --just before the ECB cut interest rates to a historic 2 percent low -- to a peak of around 2.3 percent a year later, and has since slid back to about 2.0 percent, according to data in the ECB's September bulletin.
The Reuters article does note that the "break-even rate" is not without its problems:
One thing analysts and the ECB do agree is that it is misleading to read the BEIR as a simple predictor of future inflation.
For example, the relative illiquidity of euro-denominated index-linked bonds compared with nominal bonds tends to give the BEIR a downwards bias. But their value as a hedge against inflation and their popularity with some pension funds attempting to match index-linked liabilities pushes the BEIR upwards.
Each effect might be in the region of tenths of percentage points, but it is unclear what the net impact is. This means the ECB and analysts prefer to look at changes in the level of the break-even rate, rather than its absolute level.
Even here, there is a question mark over whether the liquidity premiums on index-linked bonds remain the same over time -- not a certainty as issuance of these bonds increases.
The BIER measure is similar to the "TIPS" measure of inflation expectations in the U.S., which is subject to similar criticisms. That said:
Given these caveats, most economists say the BEIR is probably the best of an imperfect range of options for the ECB. "It's a worthy part of the armoury, but by no means a weapon that can be used on its own," James said.
For now, at least one member of the ECB wants you to know they are on the case. From Bloomberg:
European Central Bank council member Yves Mersch said oil prices at current levels risk boosting wages and feeding inflation, suggesting he may support an increase as the bank's next step on interest rates.
"The longer the oil prices remain high, the higher the risks are that second-round effects will also materialize,'' Mersch said in an interview at an event in Luxembourg late yesterday. "That's the reason why we called for particular vigilance.''