EU Economy
The German obsession with inflation and the expected ECB rate hike
By Finfacts Team
Apr 6, 2011 - 6:46 AM

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Source: Deutsche Bank Research

The German obsession with inflation is likely to trigger a decision by the European Central Bank (ECB) on Thursday to hike its benchmark rate from 1% to 1.25%.

Deutsche Bank Research says much like the Great Depression of the 1930s, which burned itself deeply into the collective memory of Americans, the hyperinflation in Germany in the wake of the First World War has shaped the consciousness of subsequent generations of Germans.

The economists say that there’s just no other way of explaining why the string of good numbers from Germany’s labour market, the prospect of unemployment falling below the 3m mark in summer and the good chances of GDP growth reaching 2 ½% this year barely attract the attention of the media or the public, whereas the inflation rate of 2.1% in February and the inflation outlook are regularly the subject of commentary.

Destatis, the German federal statistics office, said last week that it expects the harmonised consumer price index for Germany, which is calculated for European purposes, to increase by 2.2% in March 2011 on March 2010. Compared with February 2011, the index rises by 0.5%.

The target rate of the ECB is "below but close to" 2%.

German producer prices rose by 6.4% in February 2011 from the corresponding month of the preceding year. In January 2011 the annual rate of change was +5.7%.

The DBR economists say that of course it is important to keep close tabs on the path of inflation going forward - -  especially in view of a volatile oil price - -  and the ECB has spoken also in this context of its "strong vigilance." Yet an inflation rate of 2% or perhaps 2 ½% in the coming months largely represents a reversion to the normal pattern following the recession-induced lows of the past two years (2009: 0.3%; 2010: 1.1%), driven mainly by oil and food prices. In any event, on the assumption that food and oil prices return to normal the DB Research inflation model forecasts no dramatic surge in inflation. The economists say they are aware, though, that some of the structural changes of the past decades may have reduced the meaningfulness of the forecasts produced by such a model.

Destatis has said the consumer price index for Germany rose by 1.1% on an annual average in 2010 compared with 2009. Although, the year-on-year rate of price increase was markedly higher than in the previous year (2009: +0.4% on 2008), in 2010 it was still far below most of the annual inflation rates since the launch of the euro in 1999 when examined in a long-term comparison. Both on an annual average and for the individual months in 2010, the rate was below the threshold of 2% which is important for monetary policy.

The economists say recent rising inflation rates appear to be grist to the mill of those who regard a substantial acceleration of inflation as inevitable in view of skyrocketing sovereign debt and ballooning central bank balance sheets in the industrial countries. However, the economists  believe these arguments ignore the decrease in the credit multipliers, the changed role of central banks and the absence of money illusion ( Medium term inflation risks – how much of a threat are they? June 2009; pdf).

DBR says a crucial factor for the price climate is not so much the short-term repercussions of volatile energy and food prices on the headline inflation rate - -  especially since a jump in the oil price to say $100 per barrel on a permanent basis, disappears from the year-on-year rate of change after twelve months - - but rather the extent to which these effects feed through to the core rate (which excludes energy and food).

In a nutshell: whether they result in second-round effects. The economists say that over the past decade there was a roughly 50% decline in the impact of energy prices on the core rate. The food price effect decreased even more. In addition, the time needed for energy and food prices to feed through to the core rate has lengthened. This is also evident in the generally smaller correlation between headline inflation and the core rate.

SEE Page 6 of report: GDP growth and inflation – perception problems (pdf)

ECB Rate Rise "Almost a Certainty"


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