Carsten Brzeski's blog

German inflation brings comfort for ECB

A drop in headline inflation in October and strong retail sales in September provide further evidence of Germany’s goldilocks economy

While many Germans are enjoying a long weekend due to public holidays, today’s macro data suggest that the economy is in the midst of a goldilocks period. Strong industrial data over the summer, and an Ifo index at a record high, were today supplemented by strong retail sales and a falling inflation in September and October.

Retail sales, in real terms, increased by 0.5% MoM in September, from -0.2% in August, providing further evidence of strong private consumption. On the year, retail sales were up 4.1% (partly driven by favourable base effects). The strong labour market and low inflation remain the main drivers of German private consumption. And there are no signs of any changes to this picture any time soon.

In fact, inflation remains low. Based on the results of five regional states, German headline inflation dropped to 1.6% YoY in October, from 1.8% YoY in September; the first drop since June this year. Based on the harmonised European definition (HICP), and more relevant for ECB policy making, headline inflation even dropped to 1.5% YoY, from 1.8%.

Looking at the available components at the regional level shows that today’s drop in headline inflation was mainly driven by energy base effects. Measures of core inflation remained stable. Stable core inflation, however, masks two diverging trends in German prices. While prices for consumer goods have increased at an annual rate of above 2% for quiet some time, the ongoing decline in communication costs and lower prices for services continued to keep core inflation at bay.

With the current upward trend in oil prices, negative base effects from energy prices could quickly disappear again. However, ongoing structural factors like increased competition in the service sector on the back of digitalization, little upward pressure on wages due to the stronger euro, globalization and automation, should keep German headline inflation clearly below 2% until the end of the year and beyond.

As long as the current showcase model of the Eurozone economy – the German economy – which is also the most advanced in the current cycle, does not show any signs of accelerating inflationary pressure, the ECB will feel extremely comfortable with its dovish tapering.