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UniCredit Bank Austria analysis:
Inflation risk looming?

  • Prices for raw materials increased inflation in Austria to 2.0% in March.
  • Expansionary fiscal policy is not a risk to price stability due to the large output gap and the strained situation on the labour market: There is no wage-price spiral in sight.
  • The inflation risk resulting from the ECB's supportive monetary policy is an overestimation: The strong increase in the base money is not reflected in the development of the broad M3 money supply, and liquidity hoarding has a strong influence on growth in lending.
  • Inflation in Austria set to reach more than 2.5% in the course of 2021, but the increase due to oil and food prices will only be temporary.
  • Average inflation in Austria will remain moderate at 2.2% in 2021 and 2.0% in 2022.
  • Financial market expectations of medium-term inflation have recently increased in the US due to the expected strong recovery. An increase is also expected in the eurozone, albeit significantly below 2%.
  • In the long term, the anti-inflationary effects of demographic developments and globalisation are likely to weaken. The situation in Japan shows that this does not necessarily lead to higher inflation.

"The increase in government bonds in recent weeks reflects the growing concern of financial markets about a strong and sustained rise in inflation. This worry is rooted not only in the hope of an economic recovery, but also in the expansionary fiscal policy and supportive monetary policy of central banks, as well as long-term demographic changes. However, given the current conditions, the fear of an inflation nightmare is unfounded for the foreseeable future", says UniCredit Bank Austria Chief Economist Stefan Bruckbauer. In a new analysis, UniCredit Bank Austria economists provide an overview of the short-, medium- and long-term inflation prospects along with key arguments for a relatively relaxed outlook despite the recent acceleration.

Short-term, temporary rise in inflation in Austria due to prices for raw materials
In the short term, the economic recovery from the pandemic will also noticeably increase inflation in Austria due to higher prices for raw materials. Industry purchasing prices, which have already increased strongly, will be passed on to consumers at least in part during the 2021 recovery, although the highly competitive environment will likely mean that this increase remains manageable. "After an average inflation rate of 1.4% in 2020, we expect the annual average for 2021 to rise to 2.2%, with some instances in excess of 2.5% later in the year. For 2022, however, we are already estimating that inflation will decrease again to 2.0% in Austria", says Bruckbauer.

However, it is important to remember that issues with collecting data during the pandemic prevented inflation rates from being fully determined in both 2020 and the beginning of 2021. On the one hand, with businesses closed during the lockdowns, it was not possible to collect price data for all goods and services, meaning that it was also not possible to calculate year-on-year price changes. As a result, alternative methods—such as extrapolation—were necessary. This affected about 25% of the basket of goods during the first lockdown in spring 2020 and up to 20% during the lockdown in autumn 2020.

On the other hand, consumption behaviour, and therefore the make-up of the basket of goods, in Austria changed as a result of the lockdowns and restrictions on mobility, a fact that is not reflected in the official inflation calculation for the year. While food spending, among other things, rose by over 50% according to credit card statements, restaurants and hotels suffered a slump of 90%. Taking this change in consumption behaviour into account, inflation in 2020 would have been 1.6%, which is 0.2 percentage points above the official inflation rate of 1.4%.

No risk of long-term unmanageable inflation, as the output gap and labour market are slowing its momentum
UniCredit Bank Austria economists believe that there is no direct risk of inflation soaring as the Austrian economy has fallen sharply as a result of the measures taken to contain the pandemic. With capacity underutilised and especially in view of the challenging situation on the labour market, there is no upwards pressure on prices from excessive demand to be expected. Empirically, there is a negative correlation between the labour market and inflation. A fall in unemployment is associated with an increase in inflation—and vice versa—assuming that, as labour supply falls, businesses face higher wage demands, which they pass on to customers by increasing the price of their products.

"After the economic slump in 2020, the output gap in Austria is high — at least as high as it was before the crisis. Unemployment is still just below record levels, so wage pressure is likely to remain moderate over the next two years. Under these conditions, there is no danger of a wage-price spiral starting in Austria. Apart from external price influences such as prices for raw materials, inflation therefore has little upwards potential", says Bruckbauer. The core inflation rate, excluding prices for energy and unprocessed food, will rise only very moderately from its current rate of 1.3% between now and the end of the year.

Expansion of the ECB's base money does not directly influence inflation
According to UniCredit Bank Austria economists, the concern that the ECB's monetary policy, which has been particularly supportive throughout the pandemic, will cause inflation to rise has also been blown out of proportion. "While the massive bond purchases significantly increased the base money in the eurozone, the broad money supply did not increase by anywhere near as much. For inflation to be higher, however, credit demand for consumption and investment needs to be greater, which in turn would require a stronger recovery of the real economy", says Bruckbauer.

Inflation can only occur when the real demand for goods and services sustainably exceeds supply, i.e. when too much growth in money supply meets too few goods and services. The ECB's quantitative easing can therefore only lead to inflation by boosting demand. However, a sustained rise in inflation caused by the ECB’s monetary policy is not expected as long as demand-related factor utilisation is low.

Medium-term inflation expectations remain below 2% in the eurozone
Investors' expectations for inflation over the next ten years can be easily calculated from the difference in the interest rates of bond rates on safe government bonds compared with inflation-linked bonds issued by the same debtor with the same maturity. Financial market expectations for medium-term inflation have recently increased, especially in the US, following the improvement in the coronavirus crisis. However, the financial market assumes an average inflation for the eurozone of only around 1% over the next ten years, with the ECB forecasting inflation of 1.4% for 2023 and experts consulted by the ECB predicting inflation of 1.7% in the medium term. Inflationary pressure is therefore not expected to rise significantly above 2% in the medium term.

Do slowing globalisation and population development pose a long-term risk of inflation?
Despite strong economic growth and lower unemployment, globalisation and the increase in labour supply have led to low inflation in recent decades. However, these favourable demographic conditions seem to be changing. The integration of new markets into the global value chains could, at the least, slow down, and the number of working people is likely to decline in both absolute terms and relative to the population as a whole, which could lead to stronger inflationary tendencies. In Japan, however, where demographic changes such as these occurred many years ago, the slowing demand has in fact led to deflationary developments. This was mainly due to increased productivity per worker and, most recently, the increase in the employment rate.

"Due to the increasing market power of the (labour) providers, the forthcoming demographic changes are likely to lead to stronger inflationary tendencies in the long term. The situation in Japan, for example, which has been facing such problems for years, shows inflation does not necessarily have to develop in the same direction", concludes Bruckbauer.

For more information about this publication, see

UniCredit Bank Austria Economics & Market Analysis Austria
Stefan Bruckbauer, Tel.: +43 (0)5 05 05-41951;
Email: stefan.bruckbauer@unicreditgroup.at