German Inflation Is Heading Lower Rapidly; But for How Long? How Low Will It Go?
Inflation in Germany fell by 0.2% in October on the HICP measure; the core rose by 0.2%. The German domestic measure inflation was zero while the domestic CPI excluding energy rose by 0.1%. On all these metrics inflation performed quite admirably in the October report.
Not only was the October report good, but in terms of the HICP measure September was excellent as well. In September the HICP had been zero, but the core fell by 0.2%. On the German domestic measure, the CPI was up by 0.3% in September while the CPI excluding energy was up by 0.2%. September numbers for the domestic measure were not as stellar; they were mixed with the 0.3% headline gain being too strong (3.7% annualized).
Germany’s HICP- Okay, the sequential inflation numbers are behaving- trending. The HICP headline rises by 3% over 12 months, at a 2.4% annual rate over 6 months, and it decelerates to a 1.3% annual rate over 3 months. The core rate on the HICP measure is up 4.9% over 12 months. It settles down to a 3.2% annual rate over 6 months and clocks in at 1.6% at an annual rate over 3 months. That is good progression and once again it brings the 3-month inflation rate down to within the target that the European Central Bank seeks for the euro area as a whole.
The German domestic gauge- The inflation rate for Germany's domestic measure does not perform quite as well. The inflation rate is at 3.7% over 12 months, that decelerates to a 2.4% pace over 6 months then picks up to a 3.1% annual rate over 3 months. It refuses to dip down inside of the ECB's preferred target band. The German domestic measure for ex-energy inflation rises at a 4.5% annual rate over 12 months, cruises at a 2.7% annual rate over 6 months and then picks up to a 2.8% annual rate over 3 months, once again refusing to fall into the prescribed target range of the European Central Bank.
Diffusion- Diffusion calculations are executed on detailed domestic data. They show some progress but not the same excellence as the HICP. The HICP is a measure crafted to fit across all EMU members and since members could not agree on how to treat housing costs, they are absent from the HICP. Diffusion values over 50% indicate prices increasing period-to-period faster more than slower while under 50% prices are slowing more than accelerating.
Diffusion results- Diffusion in the domestic measure shows a reading of 63.6% comparing 12-month price increase to those of one year ago across all major commodity groups. The diffusion measure falls to 27.3% when applied across groups to 6-month price changes annualized against 12-month changes. However, over 3 months the diffusion metric rises to 45.5% comparing the 3-month trend to the 6-month trend across categories- close to the neutral 50% mark. These diffusion data are poor for the 12-month gauge, excellent over 6 months, but then giving a constructive, but weak signal over 3 months.
While diffusion results can and do differ from headline and/or core/ex-energy results, in this case the diffusion the domestic measures dovetail well. Headline and core inflation both fall sharply over 6 months compared to 12 months. But then over 3 months the headline rises and the core barely bumps higher. So, the diffusion and the domestic core signals are the most in sync. Diffusion applied to the monthly data is much more constructive with readings below 50%, in fact below 35%, for each of the most recent three months. However, even over 3 months with the core rising at a 1.6% annual rate in the HICP; it rises at a 2.8% pace in domestic ex-energy CPI.
Three-month gauges: can we trust them? Should we use them? In terms of 3-month growth rates for the core HICP vs. the domestic ex-energy measure, the HICP core ranking is at the 55.3 percentile mark on data back to 2002. The ex-energy domestic measure ranks at its 84th percentile- higher only 16% of the time - not nearly as good a reading. Looking at the sequential progression 3-month rates show a ‘lot of progress’ for inflation reduction looking at either measure. Many find that convincing. BUT… looking at a long time-series of dedicated 3-month growth rates only finds the current 3-month metrics either above their medians for the core HICP (55th percentile standing) or far above it (84th percentile for domestic-ex energy standing). Even though in both cases the 3-month data show a lot of progress compared to the 12-month pace, neither one on its own is really enough. On this timeline (back to 2002) comparison, both series have medians of 1.4% and averages of 1.8%. So being above the median but near it does not seem to be an issue. But each of these series also corresponds to a headline and the headline HICP on the period has a median of 1.7% and an average of 2.1%. The counterpart domestic headline metric has a median of 1.5% and an average of 1.9%. These data show that the 3-month trends even where they seem to be ‘fine’ barely generate or fail to generate minimum criteria and at time when the longer dated increases are clearly still excessive and when current trends are not established enough to trust.
Brent oil- Brent oil prices are making some mischief in the background as they clearly accelerate from 12-months to 6-months to 3-months. And then they rise strongly in two of the most recent three months. Ss there more trouble ahead?
Should central bankers go for appearances or strive for substance?- The bottom line as we see in our own U.S. data is that inflation on most measures is ‘behaving,’ moving in the right direction. And many want to take solace from that…appearance. Basically, that is a choice. But what we need are policymakers who are determined to make the progression to lower rates so, not policymakers who see trends moving in the right direction, and back off, expecting it all to continue on automatic pilot. We need policymakers of substance. Economists who want policy on ‘auto-pilot’ do not advocate running off past-trends but off more complicated metrics such as using a Taylor Rule of some sort that would have current rates even higher. A Taylor Rule for the U.S. would have the fed funds rate at 6.5% to 7.75% now. Instead, Fed policy is holding the top of its target range at 5.5% and using the progress on inflation and its own forecasts to argue policy is tight-enough. The ECB faces the same sort of lack of will. Central bankers are no longer vigilant action players; they have become cheerleaders.
The Age of Aquarius?- Every age has its own values. Volcker took his job after a period of too high and accelerating inflation. In Germany the Bundesbank (the model for the ECB) has always kept inflation at bay and moved swiftly and decisively if it went over target. But these days are not those days. Central bankers are ‘fresh off’ a period of price stability. They view inflation as an aberrant condition that, apparently, will go away more or less on its own with only a few proper suggestions from the central bank. Times change. Maybe they are right…but maybe they are wrong… And the cost of being wrong here would be high. It’s at a time like this that I like to point out that monetary policy is conducted in an environment of uncertainty- always. Basing policy on forecasts and expected values is not optimal because no one forecasts well enough to do that. Policy is made in an environment of uncertainty and central bankers need to decide which of the possible outcomes they most want to prevent. The central bankers of this new millennium do not seem to have gotten that memo. They seem content to make forecasts and to expect them to work out. History is not on their side.
Robert BruscaAuthorMore in Author Profile »
Robert A. Brusca is Chief Economist of Fact and Opinion Economics, a consulting firm he founded in Manhattan. He has been an economist on Wall Street for over 25 years. He has visited central banking and large institutional clients in over 30 countries in his career as an economist. Mr. Brusca was a Divisional Research Chief at the Federal Reserve Bank of NY (Chief of the International Financial markets Division), a Fed Watcher at Irving Trust and Chief Economist at Nikko Securities International. He is widely quoted and appears in various media. Mr. Brusca holds an MA and Ph.D. in economics from Michigan State University and a BA in Economics from the University of Michigan. His research pursues his strong interests in non aligned policy economics as well as international economics. FAO Economics’ research targets investors to assist them in making better investment decisions in stocks, bonds and in a variety of international assets. The company does not manage money and has no conflicts in giving economic advice.