(FT) — European inflation risks have mounted as a result of turmoil in the Middle East, the European Commission has warned as a fall in eurozone unemployment highlighted the robust pace of economic growth across the continent at the start of the year.
Surging energy and commodity prices mean inflation this year will be “markedly” stronger than thought with risks to forecasts “somewhat tilted to the upside” because of recent geo-political tensions, the European Union’s executive arm warned in its latest update on the region’s economy.
Tuesday’s comments came as Eurostat, the EU’s statistical office, reported the eurozone annual inflation rate hit 2.4 percent in February, up from 2.3 percent in January and the highest since October 2008.
The Commission’s forecasts and latest economic data strengthen the case for the European Central Bank taking a harder line on inflation threats at its council meeting on Thursday.
It is widely expected to signal that an interest rate rise in coming months has become more likely. The ECB has held its main interest rate at the record low of 1 percent since May 2009.
Led by Germany, the eurozone saw economic growth rebounding at the start of the year. The Commission said it expected the 17-country bloc’s economy to expand by 1.6 percent in 2011, compared with the 1.5 percent it had forecast in November.
That would mean that growth had lost little momentum after the 1.7 percent pace of expansion seen in 2010. But the pattern of growth remains uneven.
The commission said: “Germany continues to benefit from the robust external environment and strong domestic demand dynamics, whereas significant adjustment challenges still weigh on activity in several other countries.”
Bucking the European trend, forecasts for growth in the UK — not part of the eurozone — were revised down, reflecting the contraction in the British economy at the end of 2010. But the UK was still expected to expand more quickly than the eurozone, with gross domestic product rising by 2 percent, compared with the 2.2 percent forecast in November.
The Commission’s inflation forecasts saw much larger revisions. The eurozone rate would average 2.2 percent this year — compared with the 1.8 percent it had expected in November. The Commission’s forecasts are closely watched because the ECB, which will publish revisions to its projections on Thursday, uses a similar methodology.
Falling unemployment would further support the eurozone recovery. In January, the eurozone unemployment rate dipped to 9.9 percent, down from 10 percent in December. Although the fall was small, it was the first drop since early 2008 and indicated that eurozone joblessness had peaked and may have started a downward trend.
Germany continues to enjoy strong falls in unemployment. National figures for February showed a larger than expected 52,000 fall in the seasonally-adjusted total to 3.1m. The German unemployment rate dropped to 7.3 percent in February, from 7.4 percent in January, and the lowest since 1991.
© The Financial Times Limited 2011
http://www.latestnewzonline.com/mideast-turmoil-raises-eu-inflation-fears-41521.html
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Extract: “Mideast Turmoil raises EU inflation Fears”
Source: CNN business
Extract Date: March 1, 2011
Commentary Date: March 27, 2011
Word Count: 503
Relevant Syllabus Section: 3
Inflation is a substantial increase in the price of goods or services over a specific amount of time, and it currently threatens the recovery the Euro zone. The current crisis is the Middle East has sparked significant rises in energy prices, specifically oil. Because of the inelasticity of oil the Aggregate Demand rises to an extent it cannot be sustained. Inelasticity is when a product is demanded to an extent that a change in price of the product leads to a proportionally smaller change in the quantity demanded for it. Aggregate Demand is the total spending on goods and services in a period of time at a given price level. Because entire economies depend on the energy source oil it is so highly inelastic thus causing a huge demand for it. The current unrest in the Middle East has decreased the positional output of many European economies because of their heavy dependence of oil, however there is still strong demand, demand that the economies can no longer sustain, these two factors cause an inflationary gap. In the short run Oil is an Impert Push Cost of Inflation affecting Aggregate supply. Aggregate Supply is the total supply of goods and services those firms in a national economy plan on selling during a specific amount of time. Unfortunately along with the rise in prices that inflation brings companies are likely to cut their variable costs, such as of labor, material or overhead that change according to the change in the volume of production units. Companies often save by reducing labor thus increasing unemployment, the number of people seeking and able a job but jobless. The current crisis in the Middle East and its affect on the highly inelastic good of oil has the potential to wreak havoc on the European Economy.
However the Euro zone is not defenseless, it is most likely that the Euro zone will deploy Monterey Policies in order combat the inflation. Monterey Policy is the control and modification of Interest rates. Euro zone members can raise interest rates. Banks can raise their nominal interest rates in order to keep the real rate that they earn positive. These raises would keep the real rate that is earned positive. Raising the Interest Rates would cool down the economy and regain lost purchasing power. Although raising interest rates will negatively impact many small businesses, it is a necessary measure to counter the growing threat of inflation.
Diagram to the below displays how Excessive Aggregate Demand leads to Inflation
Inflation discussed in this article is Demand Pull inflation; the inelastic demand for Oil can no longer be sustained with the unrest in the Middle East.
With Increased Inflation, Unemployment will also increase, due to the rise in costs companies are likely to safe costs on variable costs such as labor, as represented in Philipp’s curve
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