Carsten Brzeski's blog

Germany: 2016 Easter bunny brings relief for ECB

Drop in German headline inflation should help ECB in taming rate hike fantasies

Based on the results of six regional states, German headline inflation came in at 1.6% YoY in March, from 2.2% YoY in February. Based on the harmonised European definition (HICP), and more relevant for ECB policy-making, headline inflation dropped even further to 1.5% YoY, again from 2.2% in February. Looking at the available components from the regional states, the drop in headline inflation was mainly the result of lower food and fuel prices, but also seasonal effects. As Easter came early last year (in March, rather than in April), lower prices for packaged holidays also pushed headline inflation down. Where available, regional measures suggest that core inflation for all of Germany should have dropped somewhat in March, mainly on the back of this Easter effect.

Looking ahead, headline inflation could jump back above 2% in April when the Easter effect will be reversed. Beyond that, however, falling oil prices and limited domestic inflationary pressures should lead to a gradual slowing of headline inflation in the second half of the year. In this regard, a closer look at almost a hundred subcomponents of German consumer prices over the last months provides little evidence of a broadening of inflationary pressures. In fact, there are still more items with an inflation rate below 1% than items with price increases of more than 2%. There are still fewer items with inflation rates of 2% or more than in late-2013, when headline inflation was hovering around 1.5% YoY.

As the April inflation data will only be released after the next ECB meeting, the 2016 Easter bunny clearly brought some late relief for the ECB. Let’s not forget that since the ECB’s March meeting, markets have increasingly priced in the possibility of a rate hike before the end of this year. A scenario, which in our view has always been extremely remote. Today’s German data and tomorrow’s Eurozone data should help the ECB in getting rid of such rate hike expectations.

Speculation about changes to the ECB’s monetary policy stance are the result of a strengthening macro outlook and higher headline inflation. Nevertheless, the ECB, in our view, is not likely to quickly change policies. Clearly not before the French presidential elections. After the elections (ie at its early-June or late-July meeting), the ECB could give its first hints at a 2018 tapering, referring to reduced deflationary risks.

To move from tapering to a first rate hike, however, would require higher inflation rates, a pick-up in wages and a further strengthening of the economic recovery. Having said this, the possible exit sequencing (a rate hike before or only after the end of QE) is likely to remain a subject of market speculation for a while. In our view, the ECB’s preferred option is still not to change interest rates before the end of QE. However, if further down the road, the ECB can convince markets that a deposit rate hike does not mark the start of a normalisation cycle, the current aim at sequencing is not set in stone.

All in all, while last year’s Easter bunny clearly brings relief for the ECB and should help taming overshot market expectations, the preparations for a soft and gradual exit package are likely to start soon.