Home Society Politicians sweat as Europe’s inflation time bomb ticks

Politicians sweat as Europe’s inflation time bomb ticks

by host

Europe’s politicians face a pressing question: When will we see the end of it?

And it’s not coronavirus they’re worried about. It’s inflation, running at the highest level since the creation of the euro.

While the unruffled European Central Bank argues the record price surge is temporary, the Continent’s politicians can’t afford to be so sanguine as angry voters struggle with their gas and grocery bills, and watch their hard-earned savings burn.

In Belgium, about one million people are facing trouble paying energy bills, pasta prices in Italy are up almost 40 percent and the vertiginous spike in energy costs is threatening to knock out swathes of Europe’s manufacturing capacity in sectors ranging from aluminum to confectionery.

This all heaps pressure on politicians to take action and they are experimenting with band aids such as tax cuts, cash handouts and price caps on food, as Europe’s central bank looks unlikely to lift rates this year.

The big question is whether this inflation spike is a flash in the pan and whether volatile energy and food prices — which are causing the most immediate pain to households — will sink back as fast as they rose, or whether this is a long-term shift that will ultimately be locked in through substantial wage hikes.

“The factors driving to high inflation in the European Union will decline, will fade, but probably not as soon as we expected,” cautioned Economy Commissioner Paolo Gentiloni on Tuesday ahead of a meeting of EU finance ministers.

“We actually have a big political problem, and we have a big problem for social equality, if we don’t see wages picking up,” said Guntram Wolff, director of Bruegel, a think tank.

While the eurozone’s headline inflation rate is running at 5 percent, there are wild regional differences. Eastern Europe is being hit particularly hard hit by runaway food prices. Inflation breached the two-digit threshold to reach 10.7 percent in December in Lithuania, the second-highest rate in the EU, largely driven by a spectacular rise in energy prices.

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“I know that not everyone will be able to pay the bills and we know that debt is growing very fast … The situation is not very good,” said Rita Latvytė, a resident of Vilnius, where heating bills soared up to 140 percent year-on-year. Households can delay their payment, but Latvytė warned that was only a temporary fix.

Counting the days

The prognosis for the price rises is far from clear, and much depends on whether a complex raft of structural problems including coronavirus-linked disruptions to supply chains and difficulties in the gas sector will keep bills at their current eye-watering level.

“I find it very difficult for economists to come out and say with great certainty it is going to be temporary, or for others to say the opposite. I think we should be modest and accept that we actually don’t know this at this stage,” said Paul De Grauwe, a Belgian economist and John Paulson Chair in European Political Economy at the London School of Economics.

For now, the ECB is keeping its powder dry and is not putting a rate hike on the agenda for this year, saying that inflation is set to fall back below the 2 percent target in 2023 and 2024.

That means the battle against inflation is likely to be fought elsewhere. “Inflation, the energy price surge and the cost of living is top of mind for European leaders — it directly impacts the pockets of voters and as a result is a very salient political problem that leaders need to resolve, or be seen to be resolving,” said Mujtaba Rahman, Europe director at political risk analysis firm Eurasia Group. “It can’t wholly be up to the ECB.”

The ECB, keen not to snuff out the post-pandemic recovery with a rate rise, says it will be monitoring whether the price pressures translate into “higher than anticipated wage rises.”

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Wage increases give politicians a headache on two fronts.

On some fronts, pay has to go up. Belgium is a key front line when it comes to wages as the country has an automatic process that legally locks in pay rises linked to inflation. Employers are campaigning hard for an exemption this year, arguing the obligatory pay hike will make exports uncompetitive, but there is little prospect that politicians would back them.

But not allowing wages to rise also carries political risks across the Continent, raising the pressure from unions, and the danger of strikes and industrial action.

“We are very worried because this inflationary wave is having a devastating impact on wages,” said Luca Visentini, secretary general of the European Trade Union Confederation.

Emergency measures

In the meantime, the politicians are rolling out measures to ease the pain.

In Italy, where gas dominates the power mix, the government budgeted €3.5 billion to counter higher utility bills. Prime Minister Mario Draghi said on January 10 that “the path of government support is important, but it cannot be the only one. It is necessary to ask those who have made great profits from this increase in the price of gas to share them with the rest of society.”

France, which has pushed with Spain — so far unsuccessfully — for a wholesale reform of the European power market, has pledged to keep the rise in households utility bills below 4 percent this year, and has promised to present new measures to this end “in the coming days,” Finance Minister Bruno Le Maire said last week.

Bulgaria has also frozen electricity and heating prices until the end of March, triggering outrage from utilities that say the measure will burn a hole in their coffers. To help the hardest hit pensioners (and also boost the country’s woeful vaccination rate), Sofia is also offering 75 leva (€38) to the elderly who get a jab.

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In Hungary, the government has announced that the price of basic food staples will be cut back to levels in October, prompting others in the region to float similar ideas. Serbia and North Macedonia had already imposed similar caps on basic goods like bread, sugar and sunflower oil.

Poland, Romania and the Czech Republic have been looking into reducing VAT rates for electricity and gas, while Poland’s Prime Minister Mateusz Morawiecki announced a raft of other measures at the end of last year to help people cope with pricier groceries, including payments to be doled out this year to low-income families of between 400 złoty and 1,437 złoty (€88 to €317), depending on household size and salaries.

Treating the root cause

The main frustration for both the ECB and the politicians is that they have virtually no ability to lance the root cause of the price crisis.

The causes behind the explosion in energy prices are hydra-headed. They include underinvestment in the gas sector, declining gas production in Western Europe and the complex market interactions of the prices of coal, gas, electricity and carbon. This is all compounded by tensions with Russia, which supplies 40 percent of Europe’s gas, and a booming revival in demand after a collapse in economic output earlier in the pandemic.

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Economists are divided between those who reckon power prices will cool in the mid-term, and those who argue that deep market dysfunction means the inflation will be entrenched.

“It is very hard for the ECB to act on the developments in a way that will be helpful. The ECB can raise rates, but that will not fill gas reserves or help fix supply chains,” Bert Colijn, a senior economist at ING bank, said.

Energy prices soared 26 percent in December year on year, accounting for around half of the rise in the Harmonised Index of Consumer Prices, a measure of inflation.

Prices have eased somewhat in recent weeks, thanks to unexpectedly warm weather and the rerouting of liquefied natural gas tankers to Europe to ease shortages — but remain historically high.

“We have seen the high water mark for gas and power prices and we do expect them to decline,” said Glenn Rickson, head of European power analysis for Platts Analytics at S&P Global.

He added, however, that because of the structure of Europe’s power market, “gas is still going to be playing an important price-setting role for many years to come.”

Latvytė, the Vilnius resident, felt there was little chance of a dramatic improvement soon: “I don’t think that in summer it will be easier.”

Johanna Treeck contributed to this report.

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