German Inflation Affirmed as Stable

Measured on the HICP headline scale, German inflation has reached the promised land. Sequentially Germany’s HICP measure is up 1.9% over 12-months up at a 1.9% annual rate over six-months and much weaker at a -0.6% annual rate over three-months. A year ago, the pace of the HICP was 2.6% so this slide of German inflation into its overall target zone for European Monetary Union-wide inflation rate has been slow and relatively consistent.

The German domestic inflation measure isn't quite as well behaved and shows more signs of simply being stable skimming just above that hallowed 2% mark. A year ago, German domestic inflation ran at a 2.2% annual rate, currently, year-over-year it's at 2.1%, the six-month pace is at 2.3%, the same as the three-month pace, which is 2.3%. None of these are deal-breakers for monetary policy since German inflation has been within a couple of ticks of the desired path even on this domestic scale now for over a year, tracking the target that the ECB seeks for the monetary union as a whole.

However, a good deal of inflation progress continues to reside in the behavior of oil prices Brent oil prices are down for three-months in a row and they've certainly helped to contribute to good performance on the overall and domestic inflation measures. Germany's domestic CPI excluding energy was up 2.6% a year ago, currently it's up by 2.8% over 12-months it's up at a 2.6% annual rate over six-months, and at a 2.7% annual rate over three-months. Once energy is excluded, Germany's domestic inflation measure is steady, much like its headline measure, however it's skimming somewhere between half a percent and eight-tenths of a percentage point above the 2% target that the ECB sets for the European Monetary Union as a whole.

The point of saying it that way, talking about German inflation compared to the target for the monetary union as a whole, is to remind everyone that there is no target for inflation in Germany there's only a target for the monetary union as a complete entity. But Germany is the largest economy in the monetary union; what Germany does goes a long way toward putting the overall European measure in its proper place. Currently Brent inflation is down 27.7% over 12 months, it's falling at a 25.4% annual rate over six-months, and dropping at a 60.3% annual rate over three-months. These sharp declines in energy prices certainly go a long way toward making the headline inflation pace for Germany as well as for EMU behave.

The HICP measure doesn't give us up-to-date energy readings yet so we cannot calculate comparable statistics for the monetary union as a whole. However, the German data are quite suggestive that if we were to do that, we would find a similar outcome, that the HICP headline appears to be well behaved but that the core would probably appear to be a little more stubborn. Regardless of that fact, the question is where the ECB would come down with its discretion. And recently central banks have been quite tolerant about inflation-overshooting. However, that worm may have turned.

A new future…unfolds or unravels Economies now face different challenges. Europe is going to be in charge of more of its own military defense and that's going to require more spending; that will create more stimulus and possibly generate more inflation pressures. In addition, there is this tariff imbroglio that could resolve either with a closer-to-free-trade result with tariffs being reduced, or a worse-result with more tariffs being imposed. A world with more tariffs or higher tariffs would be a world that was likely to be flirting with inflation a little bit more, at least over the next year or so. The ECB might still continue to be tolerant of that. However, a lot about these economic circumstances remains unknown. There's a lot of uncertainty about the performance of the US economy that can help to set the stage for how the global economy is going to perform. So, the future still offers the potential for more economic drag from a high tariff world or lower inflation performance from a lower tariff world and it's still hard to judge which of these worlds we're going to be in over the next 12- to 24-months. And now, German headline inflation is behaving quite well although the core reminds us that Germany may be farther away from its goal than the headline makes it appear, like that famous rearview mirror image in the movie Jurassic Park. Looking at things through mirrors can distort them. And at this point I don't think policymakers know exactly how to look at the future whether they know the rearview mirror from the windshield or the future from the present. There's a great deal of uncertainty, a great deal of disagreement and very little trust. Stirred together, it's not a good combination for policymakers. Double, double toil and...trouble? We shall see.