A slight increase in German inflation should bring some relief ahead of next week’s ECB meeting, amidst speculation about the ECB’s possible reaction to the stronger euro
Based on the results of six regional states, German headline inflation increased somewhat to 1.8% YoY in August, from 1.7% YoY in July. The fourth consecutive rise of headline inflation. On the month, German prices increased by 0.1% MoM. Based on the harmonised European definition (HICP), and more relevant for ECB policy making, headline inflation accelerated to 1.8% YoY, from 1.5% following three months of near-stable inflation data.
Looking at the available components at the regional level shows that today’s increase in headline inflation was mainly driven by base effects from higher energy and food prices. Measures of core inflation remained stable. At the same time, the end of the holiday season pushed down inflation in leisure costs, and the ongoing decline in communication costs and lower prices for services continued to (at least partly) offset higher prices for consumer goods.
However, these latest figures could represent an inflation peak for this year. In the months ahead, cyclical factors like the stronger euro and base effects from lower energy prices, but also structural factors like increased competition in the service sector on the back of digitalization, should push down headline inflation again.
Ironically, for the ECB today’s German inflation data is good news, as it increases the likelihood that August inflation for the entire Eurozone (to be released tomorrow) will also show a small pick-up. However, German inflation data will do little to hush the current discussion on the possible impact of the stronger euro on the ECB's tapering plans and the Eurozone in general.
In our view, next week the ECB will probably want to play down the possible negative impact from the recent euro appreciation on both Eurozone growth and inflation, stressing strong domestic demand and low interest rates. For the time being, the ECB will try to present the stronger euro as an achievement, namely increased attractiveness of the Eurozone, rather than a problem.
When preparing its game plan for tapering, the ECB will do everything it can to avoid what the ECB itself often refers to as “unwarranted tightening of financial conditions”. ‘Dovish tapering’ and ‘tapering is not tightening’ should be the leitmotivs of the ECB’s next steps.