The European Central Bank (ECB) is currently facing a tough battle against inflation in the Eurozone, which surged to 8.5% in February. This is only a slight drop from the 8.6% in January, and sticky inflation has been identified as the main culprit. The ECB's February meeting minutes revealed that Core CPI surged to 5.6%, surpassing the 5.3% expectation. Sticky inflation refers to a financial variable that is resistant to change, and it seems to be growing in acceptance as a way of describing the current inflation situation. The term was originally coined by Maynard Keynes in his nominal rigidity of wages theory.
One reason for sticky inflation is the asymmetry in the market, where prices can move up easily but not easily down, also known as sticky down. Wages tend to respond slowly to economic and company performance, and when unemployment rises, wages stay stable or rise slowly, but don't go down. This makes wages resistant to pay cuts and contributes to the sticky inflation situation. However, some economists believe that wage stickiness is an illusion because if there is stickiness in one market, real income will be reduced due to wage spillover into the cost of goods, which leads to inflation.
Keynes believed that fiscal policies were necessary to help readjust the equilibrium in a disequilibrium situation like the current one. This type of inflation is known as wage-push inflation, which is similar to what is currently being seen in the Eurozone. The ECB's efforts to battle sticky inflation will be closely watched, and investors may want to consider alternative investments, such as tokenised gold and silver (AUS and AGS), which may provide a hedge against inflationary pressures.
Sticky making the headlines again
Eurozone inflation is showing no signs of slowing down, and the European Central Bank (ECB) is taking action to curb its impact. According to market predictions, the ECB is expected to raise interest rates by 50 basis points in March, with another 50 basis point increase in May. This move is expected to help address the rising inflation rates in the Eurozone.
JPMorgan's economist Greg Fuzesi has recently upgraded their view on the rate hikes from 25Bp to 50Bp, taking their ECB terminal rate forecast to 3.75% in June. The tight labour market in Europe is identified as a factor that's fueling inflation pressures by ECB policymakers. Many firms in Europe are facing labour shortages, which is contributing to the unemployment rate remaining at a record low of 6.7%.
However, the persistent inflation may still pose a challenge to the ECB's efforts. ECB board member Isabel Schnabbel suggests that inflation may be more persistent than estimated, as there is still too much cash in the banking system despite the injection of 7 trillion euros since the Global Financial Crisis (GFC). This presents a concern for the ECB's goal of maintaining price stability in the region. AUS and AGS could be a valuable asset for investors looking for a hedge against inflation during these uncertain times.
Why is Inflation Sticky?
The Menu cost theory helps to explain why it can be costly for firms to set new prices for their goods. Businesses must take into account the expenses associated with changing menu costs, including hiring salespeople, marketing changes, and revised input/output costs. However, in the last 12 months, firms have faced a slew of challenges that have disrupted the supply chain and impacted the global economy. These challenges include low unemployment, an inability to find staff, the Ukraine Energy Shock, global climate shocks, and China's lockdown. Firms were forced to price in these uncertainties, which may have led to an overshoot in their pricing models.
Despite moderating energy prices and an easing of supply chains, as well as the end of China's lockdown, firms are still unwilling to pass these reductions through due to the high level of uncertainty risk. As a result, a sticky inflation situation has emerged, where prices are not receding. Monetary policy is being used to lift unemployment and curb demand, but it is limited in a state of full employment and low participation rates. Moreover, the cost of capital to firms has increased and is fed through in menu pricing.
Despite some positive developments, such as moderating energy prices and an easing of supply chains, firms remain hesitant to lower their prices due to the risks associated with the ongoing uncertainties. The result is a sticky inflation situation that is difficult to resolve through monetary policy alone. As we move forward, it will be interesting to see how firms adapt and evolve their pricing strategies in response to the shifting economic landscape.
Euro Strength, Sticky Inflation, Commodities and Gold
Commodities and precious metals have proven their resilience against a rising USD in a 'sticky' scenario. This is excellent news for investors who are looking to diversify their portfolios and hedge against potential inflation. The value of gold and silver has historically been inversely correlated with the US dollar, making it an attractive investment opportunity during times of economic uncertainty. This trend is expected to continue, especially given the current economic landscape, where inflation concerns and global supply chain disruptions have created a volatile market environment.
The higher Euro on rising rates is expected to lead to a weaker USD, which is great news for gold investors. Weakness in the DXY resulting from the strength of the Euro is expected to assist gold in rising in the short to medium term. This trend is expected to continue as investors are increasingly looking towards alternative assets such as AUS and AGS as a hedge against the potential risks posed by currency fluctuations and global economic uncertainty. Furthermore, the inflation problem is expected to move away from the US to Europe, making gold and silver even more attractive as a safe haven asset.
According to Jeff Currie, global head of commodities research at Goldman Sachs, commodity prices are predicted to soar by 43% this year. This positive outlook for commodities and precious metals, combined with the rate differential, is expected to make Aussie gold a more compelling investment compared to the Aussie currency. With the increasing demand for gold as a hedge against economic uncertainty, coupled with the positive market outlook, investors can look forward to a bright future for AUS and AGS.
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