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Core inflation in the eurozone hit a record in March, a setback for central bankers whose rapid interest-rate rises have exacerbated financial sector strains and caused pains in part of the bloc’s economy.
The fresh data increases the likelihood that the European Central Bank will raise its key rate again in May. It could also encourage other policy makers to explore alternative ways to cool prices rises, by targeting excessive profiteering by companies or inflationary wage increases.
The European Union’s statistics agency said consumer prices in the eurozone were 6.9% higher in March than a year earlier, a decline from the 8.5% rate of inflation recorded in February and the lowest in just over a year. Economists surveyed by The Wall Street Journal last week had expected to see a decline to 7.1%.
The sharp fall in the annual inflation rate was driven by energy prices, which surged in March last year after Russia’s invasion of Ukraine, but have since fallen back.
The core rate of inflation however, which excludes volatile food and energy prices, rose to 5.7% from 5.6%, reaching the highest level since records began in 2001. Central bankers tend to focus on core inflation as an indication of whether rate rises are cooling inflation since it better reflects the balance of demand and supply in the economy.
“This reinforces our view that the ECB will keep hiking in the coming months despite some financial stability concerns,” economists at
said.
As they consider their next steps, policy makers will be aware that further rate rises risk deepening strains in the European banking system. These strains could amplify the impact of interest-rate rises by leading to a sharper decline in lending to businesses and households than the ECB had anticipated.
This added stress in the banking system came into sharp relief when
, weakened by years of scandals and trading losses, came under intense market pressure, prompting Swiss regulators to engineer UBS Group AG’s takeover of its rival. That followed the collapse of Silicon Valley Bank in the U.S., which brought the challenges of adjusting to a sharp rise in interest rates into focus.
Policy makers have long been concerned that the surge in energy and food prices after the invasion of Ukraine would lead to an increase in pay rises, in turn prompting businesses to raise their prices and setting off a fresh round of pay demands.
Some ECB rate setters are now also looking at the inflationary potential of widening profit margins, with one official warning of a “profit-price spiral.”
“Opportunistic behavior by firms could also delay the fall in core inflation,” said
Fabio Panetta
last week.
ECB President
Christine Lagarde
has echoed that concern, saying that a refusal on the part of business owners—not just workers—to accept a decline in their real incomes could entrench high inflation.
Since the eurozone imports most of its energy, the sharp rise in energy prices since the months leading up to the invasion of Ukraine is a transfer of resources out of the currency area and to energy suppliers such as Norway, the U.S. and Qatar.
In 2022, the European Union’s energy imports cost 833.7 billion euros—equivalent to around $909 billion—more than double the €390.3 billion bill for 2021, despite a decline in energy consumption.
Eurozone policy makers often compare that loss of resources to a tax rise, and Ms. Lagarde said a sharing of that burden between workers and business owners would help contain inflation.
“It is certainly something that we would welcome, to the extent that it reduces the risk of second-round effects in particular,” she said earlier this month.
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Eurozone wages rose at an annual pace of 5.1% during the last quarter of 2022, the fastest rise since records began in 1996, with the exception of the second quarter of 2021, which was boosted by one-off pandemic-related effects.
Encouraged by an unemployment rate that fell back to a record low of 6.6% in February, some workers seeking larger pay rises have resorted to strikes. In one of Germany’s biggest walkouts in decades, a large-scale transport strike brought large parts of the country to a standstill on Monday as two labor unions sought raises of 10.5% and 12% respectively.
Data through the end of 2022 show profits have been rising faster than wages over recent years. And according to the ECB, profits accounted for a larger share of the rise in prices of goods and services than did wages during the final six months of last year. Sectors where the growth in profits has outstripped the growth in wages include manufacturing, construction,trade, transport, accommodation and food services.
“It looks to me as if this inflation shock has encouraged some of these companies to beef up their margins,” said
Claus Vistesen,
an economist at Pantheon Macroeconomics.
Some business owners have said that price rises that exceed cost increases allow companies to keep prices stable, instead of burdening customers with recurrent price increases that closely track inflation.
Central bankers don’t have any direct way to cool rising profits other than through higher interest rates that weaken demand. Elected governments and parliaments can use taxes to cap profit increases even more directly.
“Margin compression will have to happen, playing an important role in the disinflation process,” said
Marco Valli,
global head of research at Italy’s
“The longer it takes to get there, the higher the risk that the ECB would need to tighten aggressively, pushing the eurozone into the nasty-recession scenario.”
Write to Paul Hannon at paul.hannon@wsj.com
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