A casual glance at FinTwit (‘finance Twitter’) and run-of-the-mill quotes in Reuters/Bloomberg wire articles show that the inflation spike is certainly aggravating lots of folks in markets. But what about our central bank overlords in Frankfurt? Are they starting to lose their nerve over inflation? It goes without saying that ECB-speakers have been caught by surprise by the rather vigorous upswing in prices. ECB staff had forecasted a much more benign rebound in inflation.[1] Thus, the ECB’s top brass is on the defensive in the sense that they must hedge their bets when they say that the inflation bounce will end up being transitory. The hedge here is that the ECB will tighten when inflation is becoming entrenched. Or “second round effects” in ECB-speak. For the uninitiated, second round effects are an increase in the general price level – so, not just a select number of goods and services – leading to wage gains that not just exceed inflation, but inflation plus productivity growth. Which in turn forces businesses to raise prices in response.

[1] There are also Governing Council forecasts besides the staff forecasts. The former are secret, while the latter the ECB publishes on a quarterly basis.

 

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