Inflation beginning to fall again: What does it mean?

09, Jul - NEWS

Inflation in Germany continues to decline. According to the preliminary estimate of Destatis institute, the consumer price index in Germany reached 2.2% year-on-year, which is 0.2 points lower than last month. Analysts polled by Factset had expected the figure at 2.4%, the same as in May. The HICP consumer price index, which allows comparisons between eurozone countries, came in at 2.5% year-on-year in June, against analysts' forecast of 2.6% and after rising 2.8% in May.

In detailed data used by the ECB as a benchmark, the overall harmonized price index was 2.5%, also down from 2.8% in May. Inflation excluding food and energy, which is also closely monitored by the monetary authority, was 2.9% in June, down from 3 in April and May, still well above core inflation. In other words, it will take some time for the figure to reach the ECB's 2% target.

"There will still be ups and downs, but overall the trend is moving in the right direction," commented Fritzi Köhler-Geib, an economist at investment bank KFW.  Moreover, the Euro 2024 soccer tournament organized by Germany since mid-June and the flow of tourists "have not had an inflationary effect," she adds.

Labor-intensive services, whose prices rose by 3.9% in June, the same as in May, are preventing inflation from falling faster towards the target. In contrast, prices of commodities (+0.8%), food (+1.1%) and energy (-2.1%) have been trending down over the year, thanks in part to the reduction of supply chain bottlenecks.

Sluggish economy

Lower inflation in Germany is good news for the German economy, as the German economy has remained relatively "sluggish" for several months now. The country's industry is suffering from a multi-faceted crisis: high energy prices, weak domestic demand and difficulties in international trade. Rising borrowing costs and political uncertainty amid internal disagreements in the government between the Social Democrats, Greens and liberals from the SDP over fiscal policy, which are holding back investment, are also playing an important role. Germany's unemployment rate also rose slightly in June, the first time since December.

A slow economic recovery had been forecast since the beginning of the second quarter, thanks to rising consumption, exports and ECB monetary easing. Business and consumer sentiment in Germany deteriorated slightly in June, although the opposite was expected. In any case, the upturn this year looks very weak. Berlin is forecasting growth of just 0.3%. This is well below Brussels' forecasts for the eurozone, which are 0.8% this year and 1.4% next year.

Rate reduction

Despite inflation rising to 2.6% last month, the ECB decided in June to cut its key rate for the first time in nearly five years. The decision was accompanied by very cautious talk about the future outlook, as the central bank forecasts inflation to remain above its 2% target for much of next year.

Nevertheless, there is less and less doubt about the prospect of further falls. Last week, the governor of the Bank of Slovakia reassured markets. Although he favors a tight monetary policy, last Thursday he said, "I think we can expect another rate cut this year". While the Bank of Slovakia Governor's statement suggests that a further ECB rate cut at the July 18 monetary policy meeting is unlikely, it confirms that the European Central Bank has indeed entered an easing cycle.

Markets are betting on three rate cuts

In turn, money markets are currently betting on an overall 68 basis point ECB rate cut this year, with the probability of a third rate cut after the June and September rate cuts at around 70%. "The ECB can only cut rates once a quarter to bring the deposit rate to 3.25% by the end of 2024," Berenberg's Holger Schmiedin.