What Might Kick European Inflation into a Higher Gear? | Lord Abbett
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Economic Insights

Any boost to prices from economic reopening may prove short-lived.

Read time: 3 minutes

European inflation appears set to increase over the next few months because of base effects1 and rising demand amid the economic reopening. But this efflorescence could prove short-lived; after peaking in the fourth quarter of this year, inflation is expected to return to low levels, necessitating continued fiscal and monetary support.

This could prove to be a stark contrast with the United States, where markets are more convinced that inflation will return to 2% (the U.S. Federal Reserve’s target level), and instead, the concern is whether inflation will be sustainably above-target. Europe’s cyclical outlook is just less forceful than the United States, and old structural challenges remain. This doesn’t mean the story is written in stone: if the United States is successful getting inflation meaningfully higher than 2%, then this will also improve prospects for European inflation through global growth linkages.

The U.S. Connection

The important takeaway here is that inflation and rate trends in Europe are still strongly tied to developments in the United States. Consider how closely five-year, five-year forward inflation breakevens move in the two areas, with Europe at a generally lower level (Figure 1).


Figure 1. Eurozone Expected Inflation Continues to Track Below U.S. Levels
Five-year, five-year breakeven inflation rates for the U.S. and Eurozone, June 1, 2018–June 10, 2021

Source: Bloomberg and the U.S. Federal Reserve Bank of St. Louis. Data compiled June 10, 2021. The breakeven inflation rate represents a measure of expected inflation based on the yield spread between nominal and inflation-linked bonds. The latest value implies what market participants expect inflation to be in the in the United States and Europe over the five-year period that begins five years from today. For illustrative purposes only.


And it is not a one-way street: the U.S.-Europe, 10-year nominal rate differential increased steadily from July 2020, until running into a brick wall of overly aggressive rates expectations around the end of the 2021 first quarter (Figure 2). This resulted in some convergence as Europe shook off the effects of the pandemic, and U.S. rate markets cooled down. Moreover, if you think the United States will fail at generating inflation, you should definitely think Europe will fail, in our view.


Figure 2. Yield Differential Between U.S., Eurozone Bonds Has Decreased

Differential in yields for 10-year government bonds for Germany (largest European government bond market) and the United States, January 1, 2019–June 10, 2021

Source: Bloomberg. Data complied June 10, 2021. For illustrative purposes only.


The investing regime is still tilted towards higher growth and higher rates, but in Europe’s case, the European Central Bank (ECB) is likely to continue to provide support to the bond market, and the inflation composition data looks abysmal. Although there is little the ECB can do to fight it, policymakers don’t like the prospect of higher domestic rates as a result of higher foreign rates, just as Europe’s reopening is getting started.

Indeed, the ECB on June 10 decided to continue purchasing bonds at a high rate as part of the Pandemic Purchasing Program (quantitative easing), suggesting that they, too, are not entirely comfortable yet with the evolution of long-term inflation. Moreover, what we always look for in Eurozone inflation is some pickup in industrial goods inflation – important for its relevance to broad-based inflation – and in these categories, we see a heck of a lot of nothing (Figure 3).


Figure 3. Little Inflationary Pressure from Industrial Goods Prices in the Eurozone

Change in indicated subcomponents of the Harmonised Index of Consumer prices (HICP), April 1, 2015–April 1, 2021

Source: Eurostat via U.S. Federal Reserve Bank of St. Louis. Latest available monthly data. For illustrative purposes only.


A Green Boost?

One way that Europe can artificially catch up with the United States over time is through Green government policies. Under the European Union’s Emissions Trading System, CO2 certificate prices have roughly doubled in price over the past 18 months or so. The carbon trading scheme will eventually feed through into higher administrative utility prices, resulting in a small increase in Eurozone inflation over time. A second way is through the inclusion of housing prices in official inflation indices, but right now, there are no consistent monthly measures of Eurozone home prices suitable for official government statistics. The Green policy effect is more immediate and growing, while the housing price inclusion would remove one major difference between European and U.S. inflation indices.


1The “base effect” relates to inflation in the corresponding period of the previous year; if the inflation rate was too low in the corresponding period, even a smaller rise in a price index will arithmetically give a high rate of inflation to the current period. 


The value of investments in equity securities will fluctuate in response to general economic conditions and to changes in the prospects of particular companies and/or sectors in the economy.

Forecasts and projections are based on current market conditions and are subject to change without notice. Projections should not be considered a guarantee.

This article may contain assumptions that are “forward-looking statements,” which are based on certain assumptions of future events. Actual events are difficult to predict and may differ from those assumed. There can be no assurance that forward-looking statements will materialize, or that actual returns or results will not be materially different from those described here.

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The Harmonised Index of Consumer Prices (HICP) is a euro-area measure of consumer price inflation. It measures the change over time in the prices of consumer goods and services acquired, used or paid for by euro area households. The term “harmonised” denotes the fact that all the countries in the European Union follow the same methodology. 

The information provided herein is not directed at any investor or category of investors and is provided solely as general information about our products and services and to otherwise provide general investment education. No information contained herein should be regarded as a suggestion to engage in or refrain from any investment-related course of action as Lord, Abbett & Co LLC (and its affiliates, “Lord Abbett”) is not undertaking to provide impartial investment advice, act as an impartial adviser, or give advice in a fiduciary capacity with respect to the materials presented herein. If you are an individual retirement investor, contact your financial advisor or other non-Lord Abbett fiduciary about whether any given investment idea, strategy, product, or service described herein may be appropriate for your circumstances.

The opinions in the preceding commentary are as of the date of publication and are subject to change. Additionally, the opinions may not represent the opinions of the firm as a whole. The document is not intended for use as forecast, research, or investment advice concerning any particular investment or the markets in general, and it is not intended to be legal advice or tax advice. This document is prepared based on information Lord Abbett deems reliable; however, Lord Abbett does not warrant the accuracy and completeness of the information.



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