Morning Commentary: The Euro Area: Crosscurrents

A daily summary and commentary of events and factors that affect the global markets, with a particular emphasis on the foreign exchange markets.

The Euro Area: Crosscurrents  Share this story: Andrew Kositkun Senior FX Advisor

Euro area headline inflation finished the first quarter on a strong note, with year-over-year inflation acceleration of 1.3%. Inflation gains were driven by surging energy prices and increasingly favorable base effects. Core inflation also moved higher during the first quarter, although this was predominantly due to technical factors. Looking forward, further core inflation gains will likely be more challenging to achieve due to tightening restrictions in March–April and lower weighting on discretionary demand components, which tend to have positive inflation seasonality during summer months.  On the production side, growing input costs and transportation costs could get an additional boost from the Suez Canal blockage in late March. However, empirical evidence from after the Great Financial Crisis suggests that consumer prices should not meaningfully react unless, as a result of the COVID-19 crisis, firms are unable to absorb these costs by further reducing margins. Therefore, the elasticity between producer prices and consumer prices should remain low until demand-driven price pressures start taking hold and allow increased firm pricing power.  On the virus front, while the third wave of COVID-19 infections is gaining momentum everywhere in the EU, the European Commission (EC) has presented a proposal for a “digital green certificate” that will help facilitate citizens’ return to safe movement within the EU. This certificate would include proof that the person has been vaccinated, has received a negative COVID-19 test or has recovered from COVID-19. Moreover, the EC is currently working with the World Health Organization to ensure that these certificates are recognized outside of the EU. As for vaccinations, the EC still expects 360 million doses to be delivered during the second quarter, allowing the EC to remain on track to reach its goal of having 70% of the adult population vaccinated by the end of the summer. Despite this positive outlook, several member states have had to tighten restrictions due to the accelerating number of new cases and hospitalizations.  Finally, on the fiscal front, the German Constitutional Court (GCC) suspended the ratification of the Own Resources Decision (ORD). This is the legal act that allows the EC to raise funds in the financial markets to finance Europe’s recovery fund. The GCC’s decision came after an appeal by five German citizens claiming the EU Treaty did not allow for the EU to borrow in the financial markets, despite article 122 of the Treaty allowing for the EC to borrow funds in exceptional conditions. As such, the GCC suspension should prove to be just a delay. More significant concern is that some member states have yet to start the ORD ratification process. This could be the more problematic delay and put Europe’s fiscal response, which is already lagging, even further behind its peers.

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