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Economy in Brief

German Prices Are Generally at a 19-Year High
by Robert Brusca  August 27, 2021

German export and import prices flared in July with both rising by more than one percent month-to-month. Export prices rose by 1.3% as import prices rose by 2.3% after a string of months that produced monthly gains close to 2% month-to-month. And inflation pressures on the month across the board appear quite severe. But on close inspection we will see that the inflation threat, while clear and severe viewed in some ways, may not be as bad as the headline data seem to suggest.

Both export and import prices show sequential acceleration with gains larger over one year than over 12-months of a year ago. And the pace of six-month gains is stronger than 12-month and the pace of three-month gains stronger than over six months. Hence, there is sequential acceleration.

This acceleration property is carved in stone for export and import prices (NSA) excluding petroleum for the German CPI and CPI excluding energy and for the PPI and PPI excluding energy.

Without any hesitation we can assert that inflation in Germany is accelerating.

To the extent that Brent oil prices are responsible, Brent prices decelerated in July relative to June and Brent prices that accelerated steadily on the sequential profile finally failed to accelerate in the last leg of the calculation as the three-month pace for Brent at 67% is slower than its 81.2% pace over 6-months. However, oil prices rising at a 67.7% pace are still plenty strong.

The point is that inflation in Germany is strong. The gains are rising. And since inflation is a macroeconomic phenomenon a phenomenon of the general price level not of individual commodities, the fact that all major price indexes show acceleration makes is crystal clear that inflation in Germany in cooking.

So is it hot sequentially? Is that really so significant? The answer to that is yes- in spades at least this time. The far right two columns of the table calculate the queue standing of the current inflation rate over the past 19 years and the maximum year-on-year rate over that period. The calculations show that for each German price index in the table the year-on-year increase is the highest experienced in Germany over the last 19 years. So inflation is both extremely high and extremely broadly felt.

It is a testament to inflation control in Germany that a 2.8% increase in the core CPI is the highest year-on-year pace in 19 years. The level of CPI and core CPI inflation being experienced now seems low given the historic weight of these various increases. However, for Germany, a low inflation-seeking country, these are very uncomfortable results.

The very dull silver lining in this cloud of worry is that Brent price gains are not at their all-time high but only rising at a pace half its all-time high pace plus the gain has softened month-to-month.

Correlations among various inflation rates are contained in the table below. For ease of comparison, I have presented both the upper and lower panels of the table but in fact they are redundant. That is to say that the correlation of import prices with export prices is the same as the correlation of export prices with import prices. So looking at comparisons in any half of the table (above or below the greyed-in squares (that show the correlation of any measure with itself is 'one') gives you all the information you need.

This table reveals a number of truths about inflation. Note that out of 36 price correlations (excluding own correlations, of course) 15 out of 36 (42%) show correlations levels of 0.90 or better. This means that a lot of prices move together. That makes transmission and correlation hard to pin down since there are so many similar movements among price variables. Note that correlations of 0.9 correspond to an R-square value of 0.81 so correlations of 0.9 explain about 80% of the variance in the two variables; a correlation of 0.8 explains 64% of the variance and so on.

Out of the eight correlation comparisons for each price metric, most of them have a correlation of 0.90 or more against five other price metrics. This is true of export prices, import prices, export prices NSA, import prices NSA, PPI prices, and PPI prices excluding energy.

It is not true of the CPI, the CPI excluding energy or of Brent. For these three series, there are no correlations with any price metric in the table of 0.90 or more. The CPI excluding energy has the lowest correlation on this period with any index; Brent has the second lowest average correlation; and the CPI total has the third lowest correlation. The two highest correlations with other prices are with export and import prices, but that is a slightly stacked deck in their favor by having four measures of export and import prices in the table. Still, for Germany the international sector is extremely important as exports and imports dominate GDP.

The correlations help to remind us that as the Bundesbank used to do and now as the ECB shoots at a consumer pries target consumer prices are a different animal from other prices. They are linked to export and import prices but they are not directing dominated by imports; exports are a different animal altogether. While production costs matter, the correlation to consumer prices is loose as these correlations show. The CPI excluding energy has the lowest average correlation in the table with other inflation rates; it has a correlation above 0.5 with export prices, export prices excluding petrol, and the PPI excluding energy; it comes very, very, close on the PPI headline (correlation is 0.499). It is poorly correlated with import prices (those are goods shipped out of the country and consumer externally). It has a high but not tiptop correlation with the CPI total (0.81), a measure that has the CPI excluding energy imbedded in it.

The CPI excluding energy also has the smallest increase year-on-year of any measure in the table. Its three-month annualized 'hyper' inflation rate is only 3.7% although that closes in on twice what Germans are comfortable with (less than 2%).

On balance, there is lot of inflation percolating in Germany. I would not play down or minimize the risks since the historic comparison make it clear how exceptional a period this is for German inflation statistics. Yet, we can see that there is no reason to expect to see the core CPI and therefore the CPI take off at the same pace as the most aggressive metrics. All inflation measures are correlated to some extent. The lowest correlation in the table is 0.35 between Brent and the ex-energy CPI. Some measures have a lot more in common with each other than others. When we look at the guts of the CPI we are most impressed that what is different is the inclusion of the services sector where trends are slower moving and more disconnected from export and import prices. But if inflation is rising all around, labor and service sector workers will want to seek their additional piece of the pie to keep up with inflation. So the question of inflation permanence and transmissibility contains elements other than just the correlations. These correlations will change from period to period. What will make prices either responsive or not to rising prices looking ahead is how severely inflation continues to rage in import and producer prices and for how long. If inflation has staying power, there will be transmission to consumer prices as well. High inflation rates simply cannot be allowed to linger even in sectors where inflation appears to be isolated.

Look at the table again and remember the lesson of Brent. When Brent flares, we expect to see inflation flare as well. But over the last 19 years, Brent has a correlation of 0.90 or more with no other price index. Its average correlation with the price metrics in the table is a correlation of 0.73 which is the second lowest in the table. Yet, we all know the danger to inflation from oil prices depending on how policy reacts to them and how high and long they flare. In short, inflation is a complicated phenomenon. It is toothpaste best kept in the tube.

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