In France, inflation is likely to peak in 2022

The French economy is facing high inflation not seen since the 1970s. In its forecast published in September 2022, the Banque de France expects an inflation rate of 5.8% for 2022, after 2.1% in 2021 and 0.5% in 2020. For 2023, the projections indicate a harmonized index of consumer prices (HICP) whose increase would be between 4.2% and 6.9%. The probability that the inflation peak has been reached therefore appears greater than that of a continued rise in prices in the coming months.

In a recent note published for the Center for Economic Research and its Applications (Cepremap), we confirm this hypothesis. According to our estimates, there is a 10% chance that inflation will exceed 5.8% between October 2022 and September 2023.

This indicator of high inflation risk has also seen a slight decline in recent months. It had peaked in December 2021 with a 10% risk of inflation exceeding 7.26% in the year 2022. By comparison, in December 2008, at the height of the Great Recession, there was only a 10% chance of exceeding the 0.9% inflation threshold.

Compared to France, the situation appears more delicate in Germany, where the latest data show inflation at an annual rate of 10% in September 2022. We estimate that, beyond the Rhine, there is a 10% probability that inflation will exceed threshold of 9.1% during the forecast period and, in this case, the average risky inflation is 10.1%.

This high inflation risk threshold of 10% also reached its maximum value in December 2021, at 11.6%, and currently stands at 9.1% for the period between October 2022 and September 2023. The peak could therefore be exceeded here too, but inflation remain significantly higher than in France.

The gap widens from 2020

Germany therefore appears today to be clearly exposed to a higher risk of high inflation than France. To put this into historical perspective, the chart below depicts the inflation risk that has a 90% chance of materializing for these two economies since the creation of the eurozone.

This inflation risk in Germany has overall remained higher than in France since 2010, with the gap widening significantly since 2020 and the onset of the economic crisis linked to the COVID-19 pandemic.

To assess the inflation risks facing France and Germany today, we calculated the distribution of probable inflation rates by measuring the influence of several explanatory variables: unemployment rate as a deviation from its trend, composite indicator of systemic risk from the European Central Bank, average inflation observed in the last year, difference between the growth rate of the oil price and the inflation rate in the last year, inflation forecasts one year ahead of the Consensus Forecast and indicator of international tensions on the value chains of Federal Reserve Bank of New York.

This method has notably been applied previously by economists to measure risks of weak growth, inflation risks in the US and the Eurozone or even for inflation risks in Eurozone countries.

An analysis of the economic determinants of these inflation forecasts reveals in particular that exposure to pressures on value chains played a key role in the divergence of inflation risks between France and Germany.

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These value chains designate all stages of a company’s production activity, some of which may be located outside the country in which the company is located. For example, some German manufacturers may have car components manufactured in China or Eastern European countries.

The Covid-19 crisis has caused disruption in these global value chains. The restrictions have led in particular to a slowdown in the international transport of goods and situations of shortages. The graph above, where it is clearly seen that since 2020 the gap is widening between France and Germany, which is more integrated in world trade, therefore illustrates a greater exposure to these risks beyond the Rhine.

The sensitivity of high inflation risk to pressures on value chains is also almost twice as high in Germany as in France. We also estimate that if France had the same sensitivity to value chains as Germany, the risk of high inflation would have been 1.65 percentage points higher on average since 2020.

The divergence of inflation penalizes the euro area

In the context of the euro area, too large a divergence in inflation rates, such as the one described here between Germany and France, constitutes a difficulty for the European Central Bank (ECB), which has a single monetary policy instrument and a single instrument monetary policy target rate of 2% over the medium term.

However, since the inflation target is the average inflation rate of euro area countries weighted by their size, the ECB’s monetary policy now risks penalizing economies whose inflation rates deviate markedly from this average .

In a situation of high inflation, the economies most affected by inflation, such as Germany, would in fact be penalized by an insufficient reaction from the ECB, which would allow significant inflation to develop for too long. Conversely, economies less affected by inflation, such as France, could be penalized by an excessive interest rate reaction, slowing their economic activity excessively.

The evolution of the international political and economic context will therefore be crucial, through its effects on value chains, to limit the divergence of inflation risks between the German and French economies documented in our note and, more generally, the risk fragmentation of the euro area.

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