Consumer Prices

German Inflation Ups Pressure on ECB

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To spend, or not to spend? Prices are rising in Germany. Picture source: Bloomberg.

The monetary hawks will have another reason to attack European Central Bank chief Mario Draghi. For the first time in more than four years, the German economy outpaced the ECB’s inflation target of 1.9 percent, exceeding the projections of most economists.

Prices for goods and services in February rose 2.2 percent over the year prior, according to Germany’s federal statistical office. It’s not just rising food and fuel prices that are driving inflation. German companies are shifting rising costs onto consumers as employment hits record levels.

“Inflation this year is likely to be well in excess of the figure projected to date.”

Jens Weidmann, President, Bundesbank

“The reason for it is the solid economic growth with rising employment,” said Postbank chief economist Marco Barge.“It creates leeway for companies to shift higher costs – through import prices from the devalued euro – onto consumers.”

Rising inflation in Germany has only given fodder to the hawks calling for ECB President Mario Draghi to boost interest rates and wind down the central bank’s controversial bond-buying program.

“Dragi has an image problem,” Kristian Tödtmann, an economist at DekaBank, told Handelsblatt. “There’s the implication that he’s putting the stability of the financial markets over the inflation target.”

Mr. Draghi has justified the ECB’s monetary policy on the premise that it would boost inflation to 1.9 percent, viewed as the gold standard for price stability, and ward off dangerous deflation.

But with inflation in Europe’s largest economy now well above the ECB target, German economists see little justification for Mr. Draghi’s position.

“The figures should give reason to take the first step toward normalizing monetary police,” Michael Heise, chief economist at Allianz, told Handelsblatt.

Mr. Heise said negative interest rates in particular are unacceptable under the current circumstances. The ECB’s policies are having costly side effects on wealth creation and retirement, he said.

“There is no longer any argument for keeping monetary policy in crisis mode,” Mr. Heise said.

“The risks for the economy, also for the German, are high and have increased in recent months.”

Marcel Fratzscher, German Institute for Economic Research

Jens Weidmann, the president of the Bundesbank and one of the euro zone’s biggest monetary hawks, said he expects inflation to exceed projections for the entire year. The Bundesbank had projected an annual rate of inflation in Germany of 1.4 percent.

“Inflation this year is likely to be well in excess of the figure projected to date,” Mr. Weidmann said. “For Germany, an upward revision of around one-half percentage point is expected, and this might also be the case for the euro area as a whole.”

Mr. Weidmann has repeatedly called on the ECB to consider reigning in its loose monetary policy as inflation increases. But Mr. Bargel, the chief economist at Postbank, said a rise in rates is still a ways off.

“An increase in interest rates is expected in 2018 at the earliest,” Mr. Bargel said. The ECB could, however, taper its bond-buying program in 2017, he added.

But Andreas Dombret, a member of the Bundesbank’s board, wrote in a recent Handelsblatt guest column that banks need to start preparing now for a spike in interest rates by beefing up their capital buffers.

“The longer the low interest rate phase goes on, the greater the risks in the event that interest rates increase,” wrote Mr. Dombret, who is responsible for financial regulation at the Bundesbank.

An increase in rates would help the banking sector stabilize and recover over the long term, Mr. Dombret wrote. But in the short to medium term, a spike in rates could rattle banks if they don’t have enough capital set aside.

For the doves, this is exactly the reason why the ECB should refrain from changing its policy for the time being, particularly given the increased risk of political instability as anti-euro populists poll strongly ahead of upcoming elections in Holland, France and Germany this year.

“The risks for the economy, also for the German, are high and have increased in recent months,” said Marcel Fratzscher, president of the German Institute for Economic Research.

Paul Krugman, the Nobel Prize winning U.S. economist, said in a recent Handelsblatt interview that inflation in Germany needs to increase considerably. To address the imbalances in the euro zone, Germany needs to stimulate domestic demand and push inflation close to 4 percent, Mr. Krugman said.

“Germany should be doing a lot of infrastructure spending,” Mr. Krugman said. “It should be willing to run some budget deficits. Germany needs to have inflation above the euro area targets.”

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