German PPI drops off: Should We Care? If Greece Drops off Should We Care?

The graph on the left shows a good clear picture of the recent relationship between the German PPI and the CPI. It is not very impressive. The ex-energy gauges are not even very loosely correlated. However, their two trends have recently come together somewhat although if you peruse the graph that seems more a matter of coincidence than anything else.

While the PPI is more volatile and more 'sensitive' it is volatile on its own sensitivity to changes that do not impact the CPI in the same way. One is hard-pressed to look at the chart and to see the more volatile PPI as a harbinger of coming cycles in the CPI even if one looks for much shallower cycles.

The correlation matrix for the ex-energy PPI and ex-energy CPI tells the tale (see table below)

The correlation matrix shows a poor one-year correlation of 0.36 (which corresponds to an R-squared value of about 0.13). As we extend the period for correlation to two years the correlation drops to 0.236 and at three years it turns negative at -0.033.

The statistics produce a more precise statement on the relative variability of the PPI vs the CPI, a comparison that is quite apparent to the naked eye while perusing the chart. The PPI is three times more variable in its Yr/Yr rate of change than is the CPI, when both are expressed excluding energy.

While the Yr/Yr PPI inflation rate is falling off, as the chart shows, and as the table shows in comparing the 12-mo inflation rate to the previous 12-month rate (12-Mo Yr Ago), the shorter term sequential growth rates (12-Mo to 6-Mo to 3-Mo) for all three measures of the PPI in the table are showing upward pressure. Moreover, while the CPI has a declining pace when we compare the Yr/Yr rate to the Yr/Yr rate of one year ago it also shows building pressure in the headline and in the ex-energy versions from 12-months to three-months, just as for the PPI.

In the case of German inflation you have to be careful where you look and how you look before you decide if you are mollified by the trends or not. While the big swings in the PPI may seem to be reassuring there are both CPI and PPI pressures that are building over shorter horizons that are not so favorable. And with the Euro-Area crisis still in full swing the ECB seems to have no taste to switch to an inflation fighting mode.

The G-8 will meet this weekend and we can expect to hear little of what is really said behind closed doors. There is much more likely to be can kicking (as in 'down the road') than butt kicking (as in 'get your house in order').

The left wing Greek party, Syriza, is of the opinion that Euro-Area will not cut Greece off. Thus Greece is having its moment of bravado. If Alexis Tsipras, Syriza'a leader, can convince more Greeks that this is true he may be able to increase his party's standing in the next elections. But that is only if Greece lasts that long.

After the recent elections and the inability to form a new government I thought that the message to the Greek people was to vote for one of the traditional parties to try to re-form a government to make hard choices. My take on that election was that the radical left would not play ball and would not compromise on the issue of austerity. To me it implied that if they became more powerful Greece would exit the Zone. But the message from Mr Tsipras is quite different from this supposition. It's that he wants to stay in the Euro-Area, that he will repudiate the debt if need be and that if Greece is tossed out of the Zone it can pay its own bills and deal with the kind of austerity they would have had anyway but without outside influence. It is not clear to me that this is an honest appraisal of the situation as Greece has huge budget gaps to close if it is without the disbursement of bailout funds. But this is politics. Moreover, Tsipras asserts that Europe would never cut off Greece because it would hurt the rest of Europe too much. This is a bold gamble.

With capital flight in full swing the idea that Greece has funds to last to June is now in flux. With Tsiras making this sort of threat I'd be surprised if Greece got any help in its current gambit. Greece may not make it to the next elections unscathed. I think Tsiras has it wrong. I think Europe is not ready to continue to bankroll Greece without major changes. Also Greece will be in much worse shape if it goes out on its own now with such a shortage of tax revenues. We may soon find out which view of reality is correct. The way Greece is going odds are that events will put the ECB in an even more difficult position.