Carsten Brzeski's blog

More German worries for the ECB

German inflation increased to 2-year-high in October

Based on the results from six regional states, German headline inflation in October came in at 0.8% YoY, from 0.7% in September. Based on the harmonised European definition (HICP), and more relevant for ECB policy making, headline inflation increased to 0.7% YoY, from 0.5% YoY in September. Headline inflation is now at the highest level since October 2014.

Looking at the available components from the regional states, the fading base effect from low energy prices is still the main driver of the gradual increase in headline inflation. At the same time, prices for consumer goods and transportation have started to increase. Still, for an economy that is currently operating at full employment and with a positive output gap, inflation rates at around 1% are still extremely moderate and definitely do not signal any overheating of the German economy. Looking ahead, the recent increase in oil prices should lead to a further gradual acceleration of German inflation towards 1.5% in the coming months.

Today’s German inflation data will not make the ECB’s already difficult life any easier. Particularly on the day that Germany is celebrating the World Savings Day, falling real interest rates will hardly increase public support for the ECB. Adjusting for today’s inflation data, the ECB’s real policy rate has now dropped to the lowest level since the end of 2014. While lacking German support for QE is well-known and the ECB has learnt to live with it, higher inflation rates in Germany and the entire Eurozone could spark the discussion on another issue of higher relevance to the ECB: the tapering discussion. With headline inflation probably increasing in the entire Eurozone in the coming months, the December meeting is not only the most likely but possibly also the last moment to find wide support within the ECB’s Governing Council for an extension of QE; either at the current or maybe even at a slower monthly pace.