Monday, October 31, 2011

31/10/2011: Stagflation on Europe's doorsteps

Euro area preliminary inflation estimate came in today with October reading at 3.0%. This is the second month in a row with inflation anchored at 3.0% and coupled with the signs of a recession (see charts below showing eurocoin leading growth indicator for October at -0.13, signaling contraction in economic growth) we are now in the stagflationary territory.

 You can see the dramatic deterioration in inflation-growth dynamics year on year in the chart above. The chart below shows updated 'optimal' inflation-consistent zone for ECB rates at over 4.0% against the current rate of 1.50%.
The above suggests that the ECB is now boxed into the proverbial stagflationary corner - lowering rates to improve growth outlook will risk pushing inflation even higher, while hiking rates or even staying put at current rates risks continuing deterioration in growth fundamentals.

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