Despite low unemployment, record high employment, wage increases and, above all, the accursed ultra-loose monetary policy of the ECB, German inflation remains close to zero. Based on the results of six regional states, German headline inflation increased in June to 0.3% YoY, from 0.1% YoY in May. On the month, German prices increased by 0.1%. Based on the harmonised European definition (HICP), and more relevant for ECB policy making, headline inflation increased to 0.2% YoY, from zero in May.
Looking at the available components from the regional states, headline inflation is currently not only kept low by low energy prices but also by some tentative second round effects on consumer goods and dropping prices in communication. At the same time, annual inflation rates in services and leisure costs have increased somewhat, explaining the small increase of headline inflation.
While the small uptick in headline inflation could have brought some relief to the ECB, the British Brexit vote has clearly started new speculation about possible additional measures. Many market participants are currently expecting another rate cut in September. In our view, there won’t be any imminent and strong reaction by the ECB unless market turmoil intensifies significantly. Besides the psychological and sentiment impact, the real economic impact from the Brexit vote on the Eurozone economy should remain limited in the coming months. Once these effects start to lower investment and spending, the ECB is likely to take new actions. This could be the case at the September meeting, when there will be a better assessment of the first economic impact from the Brexit vote, both from hard and soft indicators. Moreover, a new edition of the ECB’s staff projections will be available at the September meeting. In our view, however, and judging from recent comments of ECB officials, the ECB’s awareness for adverse effects from negative rates has increased, making a rate cut less likely as the first line of defense. Instead, an extension of QE until the end of 2017 looks like a more plausible option.
Talking about Brexit, latest news from Berlin and Brussels indicates that German chancellor Merkel’s stance on the British referendum and Brexit negotiations has changed significantly since last Friday. Merkel’s position seems to have changed from a pure ‘taking-notice’ and unexcited tone towards a clear signal that life outside the EU should not be more attractive than life inside, stressing that keeping EU privileges within keeping the obligations was not possible.
Combining today’s inflation data and latest political comments, It is obvious that politics and not so much economics will dominate markets and headlines in the coming weeks and months.