European inflation is far from uniform, at 6.8% in Germany and 1.6% in Spain. On the whole, it continued its slow decline to 5.5% in June, according to Eurostat’s advanced estimate, against 6.1% the previous month. But this figure hides a much more delicate reality.
Firstly, the bulk of the decline is attributable to energy prices (-5.6% year-on-year), with underlying inflation rising somewhat to 5.4% in June, compared with 5.3% in May. The main cause of this persistent inflation is the price of services.
Added to this is the non-transformed food, whose prices are falling gradually, increasing by 9.6% over one year. In the expenses of services, as in those of food products, the cost of labour is a determining factor, and the willingness of companies to preserve their profit margins. However, the labour market remains in full shape, leaving workers in a position to demand ever-higher wages to maintain their purchasing power. In May, the unemployment rate fell to only 6.5%, the same level as the previous month and a historic low. This does not bode well for a decline in wage tensions, despite what Christine Lagarde and the European Central Bank think.
Then there are worrying divergences within the euro area itself. If Spanish inflation is now in line with the objectives of the eurozone, it is because, on the eve of general elections in the country, Madrid has multiplied all kinds of aid and subsidies. A populist policy that weighs on the public finances of a country already quite indebted (the Spanish public debt still represented 113.2% of GDP in the 4th quarter according to Eurostat, against 93% on average in the eurozone) And that necessarily starts the debate about what the standardisation of public spending will be.
Other countries are calling for a return to the norms of the Stability and Growth Pact and have not hesitated to let inflation slip away. This is the case in the Netherlands, where it peaked at over 17%, and in Germany, it exceeded 11%. In the future, asking these countries, which have exposed their citizens to a much higher price increase to preserve their public finances, to help those who have gone into debt to avoid doing the same will inevitably be a problem.
For now, the ECB’s targeted debt buybacks are keeping everyone afloat. But as key interest rates continue to rise, the market will likely return to fundamentals.
Nevertheless, Eurozone sovereign debt, which offers more attractive yields than in the past, remains in our portfolios.