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Carsten Brzeski's blog

Germany: New inflation is food for ECB critics

German inflation exceeds the magical 2%-level... without magic...

Based on the results of six regional states, German headline came in at 2.2% YoY in February versus 1.9% YoY in January. Based on the harmonised European definition (HICP), and more relevant for ECB policy-making, headline inflation also came in at 2.2% YoY; the highest level since August 2012. 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 also increased in February, but remained below its December level.

Same procedure as every month? With German headline inflation at/above the magical 2% level, new complaints against the ECB’s loose monetary policy and new media headlines are likely to emerge; though with little impact on next week’s ECB meeting. 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. Developments of core inflation will determine future ECB action. 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. However, contrary to the situation at the beginning of the year, it seems as if the debate at the ECB has been taken off front pages and media headlines to discussions behind closed doors. Recent statements of German central bankers seem to hint at a slightly changed strategy of the internal critics of the ECB’s current policy. The partly loud and outspoken criticism has given way to a more subtle tone. Last week, ECB board member Lautenschläger even started to praise increasing inflation, only to add that it would enable the ECB to reach its goals.

On the eve of the first two important elections in the Eurozone, the ECB will in our view choose not to distort the market with tapering rumours. If and when the elections in the Netherlands and France manage to reduce political uncertainty, the ECB could already give first hints at 2018 tapering this summer. Such a timing would help mitigate ECB bashing in the upcoming German election campaign. It seems that at least German central bankers are willing to keep their verbal powder dry until then.