Friday, March 28, 2014

German CPI data brings no relief for ECB

Inflationary pressure in Germany remains low. Based on the results of six regional states, German headline inflation dropped to 1.0% YoY in March, from 1.2% in February. On the month, German prices increased by 0.3% MoM. Based on the harmonised European definition (HICP), and more relevant for ECB policy making, headline inflation decreased to 0.9%, from 1.0% in February. Looking at the available components at the regional levels shows that the drop in headline inflation was mainly driven by lower energy prices, the continued decline in communication costs and last year’s Easter Bunny. In 2013, Eastern was in March which pushed down prices for vacation trips. While there hardly is a 100%-guarantee for anything in economics, it is for sure that the negative effect from Eastern will be reversed next month. Today’s inflation data do by no means signal any deflationary tendencies in the German economy. To the contrary, inflation data should rather be filed under Mario Draghi’s famous label “with low inflation, you can buy more stuff”. Unless energy prices unexpectedly drop further, today’s reading should mark the trough in German headline inflation this year. Due to reversed base effects, headline inflation should increase in the coming months before flattening out over the summer months. For the ECB, however, German inflation data could cause another headache in Frankfurt. Earlier today, Spanish March inflation was reported at -0.2% YoY, from 0.1% in February, increasing the odds that Eurozone headline inflation has slowed down further in March. While latest confidence indicators have confirmed the ECB’s base case scenario for the economic recovery, inflation has and probably also will fall short of expectations. We don’t think that the ECB will react to a single data release but Monday’s inflation data could tip the balance in a Governing Council which does not seem to have made up its mind yet. At the current juncture, we still think that the ECB’s preferred next policy option is to do nothing. First of all, current deflationary tendencies are mainly the result of supply shocks with potentially positive consequences (lower energy and food prices, improvement of competitiveness). Secondly, headline inflation should accelerate in the coming months due to reversed base effect. Finally, the instruments the ECB has available in its toolbox largely look like illusionary giants: giant from a distance but rather unimpressive in terms of effectiveness, practicability and indisputability. All of this means that most likely outcome of next week’s ECB meeting is that the ECB will continue talking the talk in order not to have to walk the walk.

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