With headline inflation close to the magic 2% level, German pressure on the ECB is likely to increase further
Based on the results of six regional states, German headline came in at 1.9% YoY in January, from 1.7% YoY December. Based on the harmonised European definition (HICP), and more relevant for ECB policy making, headline inflation also came in at 1.9% YoY; the highest level since July 2013.
Looking at the available components from the regional states, the increase in headline inflation was mainly driven by higher energy and food prices. Where available, regional core inflation measures suggest that core inflation for all of Germany actually fell in January, reaching its lowest level since October.
Following today’s inflation data, German ECB-bashing is very likely to gain further momentum. Even before the last ECB meeting, experts, policy-makers and the media had been more vocal in their criticism of the ECB. Last week, Bundesbank President Weidmann and the German member of the ECB Executive Board, Sabine Lautenschläger, also contributed to the debate. Obviously, increasing inflation – no matter what the drivers are – combined with low interest rates leads to even more negative real interest rates and hurts savers. Based on the central bank’s main policy rate and headline inflation, one has to go back to the 1970s to find similar negative levels of the real interest rate. At the same time, however, the common German reflex to criticize the ECB and call for an end of QE is, in our view, overblown.
First of all, there is very little the ECB can do about an increase in inflation, almost exclusively driven by energy and food prices. Secondly, even in an economy operating at full employment and which is most advanced in the current cycle, underlying inflationary pressure remains low; illustrated by the drop in core inflation. Thirdly, even if German inflation was to exceed 2% sustainably, it is simply a mathematical prerequisite for the inflation in the entire Eurozone to also get close to 2%. Nothing the ECB should do about. Fourthly, the current increase in headline inflation in the Eurozone is broadly in line with the ECB’s own projections. As the ECB has often stressed: these projections are conditional on full implementation of QE until the end of 2017. Finally, the ECB conducts monetary policy for the entire Eurozone and not for the best student in class.
The German push for early tapering will continue. It will, in our view, at least take until the early summer before another reversal of base effects should significantly push headline inflation down again. At the same time, however, the current public debate between Germany and the ECB almost looks like an artificial dispute or semantic discussion with one big loser: the ECB’s credibility. In fact, with the current growth prospects, it should be relatively easy to find a broad majority within the ECB to announce tapering in the summer, in the form of a further reduction of the monthly QE purchases from January 2018 onwards. A relatively reasonable and face-saving compromise. However, by starting a permanent public mud fight, where actually no fight is needed, the ECB’s reputation is likely to suffer.