Why inflation in the US and the eurozone are not the same

Infla­tion trends are very sim­i­lar in the US and the euro area. The data shows that it start­ed to rise at the begin­ning of 2021, peaks at 8.5% in the US and 10.6% in the euro area between March and Octo­ber 2022, and has been declin­ing steadi­ly and slow­ly since then. 

Nev­er­the­less, there is a clear dif­fer­ence between the US and the euro area in terms of the caus­es of infla­tion, the impacts of the dif­fer­ent com­po­nents and the expla­na­tion of total infla­tion. To under­stand this, we need to dis­tin­guish between three com­po­nents of infla­tion: ener­gy and food prices; actu­al rents and rents attrib­uted to home­own­ers; and infla­tion exclud­ing ener­gy, food, and rents.

The rise in ener­gy and food prices slows sharply in the US: from 23% year-on-year in June 2022 to 9% year-on-year in Feb­ru­ary 2023. In look­ing at US infla­tion sta­tis­tics, it is impor­tant to note the role of ris­ing actu­al and attrib­uted rents for home­own­ers – known as imput­ed rent. This is a par­tic­u­lar­i­ty of the US infla­tion mea­sure. It includes a com­po­nent rep­re­sent­ing the attrib­uted rents that home­own­ers would pay, which move almost exact­ly in line with the move­ment in actu­al rents.

These fic­ti­tious rents, attrib­uted to the own­ers of dwellings, have a con­sid­er­able weight, which brings the total weight of rents (effec­tive and imput­ed) to 38% in the US price index. In the Euro­zone price index, only the actu­al rents paid by ten­ants of dwellings are tak­en into account, which leads to a much low­er weight of rents – of the order of 6%.

Rents (actu­al and imput­ed) in the US are ris­ing quite rapid­ly (8% today) and con­tin­ue to accel­er­ate. They are react­ing with a delay of a lit­tle more than a year to the evo­lu­tion of US house prices, which reached 20% growth over a year before slow­ing down con­sid­er­ably. In Jan­u­ary 2023, house prices have only increased by 4% per year, and over the last few months, they have even declined.

We should there­fore expect rents (actu­al and imput­ed) in the US to sta­bilise or even fall if the time­frame is the same as in the past, from the sec­ond half of 2023. Final­ly, the true under­ly­ing infla­tion can be con­sid­ered as infla­tion exclud­ing ener­gy and food prices, as well as exclud­ing rents. More­over, it is this mea­sure of infla­tion that allows for inter­na­tion­al com­par­isons, due to the very dif­fer­ent treat­ment of rents from one coun­try to another.

Strong dis­in­fla­tion has start­ed in the US.

Infla­tion defined in this way shows a peak in late 2021 and ear­ly 2022 at 8% in the US, and declined rapid­ly since then, to just 3.5% in ear­ly 2023. This shows that a strong dis­in­fla­tion has start­ed in the US, which is hid­den by rental growth (actu­al and imput­ed) that will only reflect the decline in house prices in the sec­ond part of 2023 with a long delay.

Ener­gy and food prices slow down sharply (from 32% year-on-year in June 2022 to 18% year-on-year at the begin­ning of 2023), as all com­mod­i­ty prices (oil, nat­ur­al gas, agri­cul­tur­al com­modi­ties) decline. Effec­tive rents only increase by 2.3% year-on-year in the euro area and there­fore do not con­tribute to the rise in inflation.

If we use the same def­i­n­i­tion of core infla­tion as above (infla­tion exclud­ing ener­gy and food, and exclud­ing rents), we see a steady rise in infla­tion defined in this way in the euro area: from less than 1% at the begin­ning of 2021, to 3% at the begin­ning of 2022; 6.7% in Sep­tem­ber 2022, 7.4% in Jan­u­ary 2023.

Unlike the US, core infla­tion, exclud­ing rents, in the euro­zone is ris­ing con­tin­u­ous­ly. What is the source of the sharp dif­fer­ence in infla­tion dynam­ics between the US and the euro area, when con­sid­er­ing infla­tion exclud­ing ener­gy, food, and rents?

In the Unit­ed States, the fall in infla­tion since the begin­ning of 2022 comes from the fact that there is no longer any increase in cor­po­rate prof­it mar­gins and that the growth of wages and unit labour costs is slow­ing down (from 5% to around 4% per year at the begin­ning of 2023). This slow­down will become more pro­nounced at the end of the year, with rents slow­ing as a result of falling house prices and wages being indexed to 2023 infla­tion, which is sig­nif­i­cant­ly low­er than 2022 inflation.

Jerome Pow­ell, Chair­man of the US Fed­er­al Reserve, has prob­a­bly won his bet: to show a sharp drop in infla­tion in 2023, while avoid­ing a reces­sion. In the euro­zone, the rise in infla­tion (still cal­cu­lat­ed exclud­ing ener­gy, food and rents) that con­tin­ues into 2023 comes on the one hand from the faster rise in wages in 2023 than in 2022 with a pur­chas­ing pow­er catch-up effect and in the absence of pro­duc­tiv­i­ty gains; on the oth­er hand from the rise in cor­po­rate prof­it mar­gins that has last­ed since late 2020.

It is impres­sive that com­pa­nies in the euro area have man­aged to increase their prof­it mar­gins at a time when ener­gy and oth­er com­mod­i­ty prices were very high. This increase is respon­si­ble for a surge in infla­tion at the begin­ning of 2023 of almost 2 per­cent­age points. This surge in infla­tion (exclud­ing ener­gy, food, and rents) in the euro area sug­gests that infla­tion will be very resilient down­wards, as it leads to high­er wage increas­es, and that the catch­ing up of prof­it mar­gins and cor­po­rate prof­its may be far from over.