The U.S. May Have Inflation Issues, But Take A Look At Europe

The U.S. recently saw some good inflation news. Falling energy costs bought down inflation for the month of July, suggesting the U.S. might be past peak inflation and the Fed may dial back slightly on a massive rate hike next month.

Europe is not so lucky. A recent report from Citi has U.K. inflation hitting 18% next January. That makes the current U.S. inflation rate of just over 8% look relatively mild. In fact, last week we heard that German producer prices were up an eye-popping 37% year-on-year. Producer prices are often more volatile than consumer prices, but for Germany, it’s a worrying trend, especially as U.S. inflation may be slowing.

The OECD has a similar view with inflation in many European countries running well ahead of North America. All European nations except France and Switzerland will see higher inflation in 2022 than the U.S. based on recent OECD estimates.

Energy Costs

Part of the reason for the difference in inflation rates is energy costs. Specially, the issue is the rising cost natural gas. Last week the cost of natural gas in Europe hit $410 a barrel on an oil equivalent basis.

The cost of natural gas in the U.S. has risen too, but to far lower absolute levels. In part, that’s because Russia was a major supplier of European natural gas, and those supplies have declined with the Ukraine war.

In contrast, the U.S. has become a major natural gas producer over recent decades. Unlike many commodities, natural gas is bulky and difficult to transport. That’s why prices can be far higher in Europe than the other side of the Atlantic. LNG offers one method to transport natural gas, but there isn’t sufficient infrastructure for LNG to bring U.S. and European gas prices into line. So the U.S. is exporting natural gas, but not enough to bridge European demand.

A Bleak Outlook

This sharp inflation is leading to a bleak European outlook. The Bank of England is on record earlier this month warning of a U.K. recession. In the U.S. a recession is a clear possibility, but one the Fed still hopes to avoid despite yield curve inversion.

So though the U.S. may have passed peak inflation, Europe may well still have more inflation to come as natural gas prices surge on the continent. In a world of global trade, even if the U.S. dodges a recession, sluggish European growth could weigh on global markets into 2023.