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Inflation came in at 4.4% in March, it concluded CBS based on provisional figures. This means that inflation is much lower than a month ago, when prices were on average 8% higher than a year earlier. It was no surprise that the inflation rate would be much lower this month, as the figure relates to price developments compared to a year ago. Last February, the prices of various energy sources skyrocketed as a result of Russia's invasion of Ukraine, an effect that is fading now that we are comparing to March 2022. But we don't notice that yet in the prices of groceries and other products and services. Why is that?
Energy prices skyrocketed this time last year due to Russia's invasion of Ukraine. In addition to the threat of war, there was also great uncertainty about the supply of energy from Russia, which was still a Major supplier of oil and gas. Shortly after, European sanctions against Russia followed, including the intention to block the import of Russian energy sources. It caused a wave of speculation in the energy market, with the price of natural gas in particular rising to record highs. The plan of European countries to accelerate the replenishment of their gas reserves even caused the price to spike to a record of in the summer (!) of 2022 more than €300 per MW. By comparison, that was eight times as much as the price level just before the war. The price of fuels in Europe due to dependence on Russian crude oil.
We are now a year later and the market has adapted to the new reality. Due to energy savings and a mild winter on the one hand, and an increasing supply of liquefied gas on the world market on the other, the feared shortages did not materialise. In fact, the gas price has now returned to pre-war levels. And the sanctioned Russian oil and diesel? It can be found via Various detours its way to the world market and even to Europe. Combined with a significant drop in the price of oil, this results in lower prices at the pump.
This development is reflected in the figures released by Statistics Netherlands (CBS). For example, energy prices last month were on average 28% lower than in the same month last year, which means that this part of the inflation figure has now become negative. And with the prices of many fuels only peaking in the summer of 2022, this component of the inflation rate is likely to fall further in the coming months.
But that probably won't bring inflation back to pre-war levels. As the graph below shows, food prices have risen sharply recently. In March, groceries in the supermarket were on average 15% more expensive than a year ago, according to measurements by Statistics Netherlands. In Germany, food prices were even higher in March more than 20% More expensive than a year ago.
The fact that food prices are still rising is due to the fact that energy is an important raw material for the production of many foodstuffs. As a result, higher prices of fuels, fertilizer, energy, refrigeration and the like are reflected in the inflation figures with some delay. Certain raw materials, such as grain and sunflower oil, have also temporarily become scarcer and more expensive due to the war in Ukraine. In addition, bird flu plays a role, because the price of eggs has risen as a result. All these effects together result in significantly higher prices in the supermarket. Also, many food producers have taken the opportunity to increase profit margins, because due to high inflation, that difference is now much less noticeable.
Inflation falls due to lower energy prices, but food is still becoming more expensive
As the graph above shows, food prices (yellow line) always react with some delay to periods of rising energy prices (green line). In recent decades, there has been an average delay of about a year between the peak in energy prices and those of food. That would mean that the rise in food prices will peak within a few months. This is not to say that food prices will eventually return to pre-war levels in Ukraine. Historically, it is rare for food prices to really fall. As the graph shows, the year-on-year change in food prices rarely falls below zero percent. To do so, energy prices will probably have to fall even further.
The impact of higher energy prices is expected to disappear from inflation data later this year, provided that the global geopolitical situation does not escalate further. But that is unlikely to be enough to bring inflation back to the 2% level desired by central banks. As the graph below shows, inflation is becoming more and more deeply rooted in the economy. Core inflation, the figure that excludes food and energy prices, continues to show a strong upward trend. Central banks will be keeping a close eye on this figure in the coming months. It provides insight into the price increase of durable consumer goods and services, in which wages also play a role. Central banks' fears are that high inflation will become permanent when workers demand full compensation for inflation. ECB President Christine Lagarde warned of this in a Recent Speech:
"If both workers and firms accept a fair distribution of the burden, and a stronger increase in wages means only a restoration of the balance between labour and capital, then both wage and price pressures should ease as this process unfolds. But if both sides try to unilaterally minimize their losses, there could be a feedback mechanism between higher profit margins, wages and prices."
Inflation is getting deeper and deeper into the economy
In short, high inflation in the Netherlands and in the rest of Europe means an immediate loss of purchasing power. High energy prices and wage demands have worsened the competitiveness of many European industries, especially in energy-intensive sectors. The money that we, as European consumers and businesses, pay for our energy disappears into the coffers of countries that supply this energy to Europe. Think of Russia, Norway, Saudi Arabia, Qatar and the United States. It is the challenge of European government leaders to divide that bill as fairly as possible. As Lagarde said in her speech:
"The eurozone has suffered a large trade loss due to rising energy prices, the cost of which will ultimately have to be shared between companies and workers. And it is important that the burden is shared fairly between them, with both accepting that they have paid part of their income to the rest of the world and cannot fully recoup the resulting loss of production."
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On behalf of Holland Gold, Paul Buitink and Joris Beemsterboer interview various economists and experts in the field of macroeconomics. The aim of the podcast is to provide the viewer with a better picture and guidance in an increasingly rapidly changing macroeconomic and monetary landscape. Click here to subscribe.
