- Significant Decrease in Inflation Rates in August - Potential Rate Adjustments Ahead?
Monthly cost Increases in Germany slowed down to their weakest pace in over three years in August. The inflation level was at 1.9% compared to the previous year, as per the Federal Statistical Office's reports. Notably, energy costs decreased compared to the previous year, while service expenses increased above average. Food prices rose by merely 1.5%.
The German government praises this development, which several economists foresaw. Chancellor Olaf Scholz (SPD) wrote, "People have extra cash in their pockets." He further added, "Inflation is decreasing, and real wages are rising for the fifth consecutive quarter."
The stress on consumers lessened following several years of high inflation levels. In July, the consumer price index increased by 2.3%, following 2.2% in June and 2.4% in May. The last time a lower inflation rate was recorded was in March 2021, with prices also being 0.1% lower than in July. The core inflation rate, without accounting for energy and food, decreased by 0.1 points to 2.8%.
ECB's Possible Interest Rate Reduction Plan
The German flash estimate now gives the European Central Bank (ECB) the basis for a potential interest rate decrease in September, claims economist Carsten Breszki of the online bank ING. However, it's too early to talk about a lasting trend due to expected wage boosts. Inflation will remain within the range of 2-3%, rather than lingering at the lower end. On Friday, Eurostat will publish the euro area's inflation forecast, which is predicted to be slightly higher than in Germany.
Deka chief economist Ulrich Kater cautions the central bank about possible inflation increases towards the end of the year. He suggests mild interest rate cuts as the most fitting response of the currency guardians to the softening inflation environment.
Decision in September
If inflation in Germany and the euro area decreases throughout the year, it will give the European Central Bank the opportunity to lower interest rates. In June, they cut interest rates for the first time since the inflation surge by 0.25%. In July, the ECB kept interest rates stable and left the door open for a possible interest rate cut at the meeting on September 12. An interest rate decrease by the ECB is expected in September.
In principle, the ECB sees an inflation rate of 2% as guaranteeing price stability. Reduced rates or even decreasing consumer prices (deflation) can lead companies and consumers to postpone their investments and purchases due to the expectation of even lower prices, negatively affecting economic growth.
Economists had previously anticipated a trend towards price stability during the summer. For example, the Munich-based Ifo Institute expects an inflation rate of less than 2% in Germany in the upcoming months. The basis for this is a survey of companies about their price plans, which was also published on Thursday.
Consumer Spending Has Not Picked Up Yet
Despite increasing wages, many people continue to save. Private consumption dropped by 0.2% compared to the previous quarter in the second quarter, according to the Federal Statistical Office. Moreover, consumer sentiment dimmed in August, as indicated by the consumer climate study by the Nuremberg-based institutes GfK and NIM.
In the long run, consumer purchasing power has decreased during the inflation wave. However, German employees are making up for the loss of purchasing power from the high-inflation era. In the second quarter, wage increases outpaced consumer price developments for the fifth consecutive time, with the Federal Statistical Office reporting a real wage increase of 3.1% for the second quarter.
Considering the significant wage increases, private consumption remains the main hope for the German economy, which shrank by 0.1% in the second quarter. Economists expect little improvement for the second half of the year. The German Federal Bank expects minimal growth of 0.3% for the current year.
False Expectations
Economist Friedrich Heinemann from the ZEW economic institute in Mannheim believes that the hope that the decreasing inflation rate will now boost consumption is likely misplaced. "The service inflation is still causing uncertainty among many people. The new numbers indicate a temporary success, but not yet a breakthrough towards price stability."
Similarly, economist Sebastian Becker from Deutsche Bank Research sees ongoing challenges, even if the annual inflation rate remains below the 2% mark in September and October. It is likely to increase again towards 2.5% by the end of the year. "This suggests that the further course may be bumpy, and the inflation problem is not yet fully resolved."
Destatis Announcement Real Wages Q2/2024
The SPD, being a part of the German government led by Chancellor Olaf Scholz, celebrates the slowed down increase in monthly costs and decreasing inflation rates, stating that people have extra money in their pockets. With the European Central Bank considering a potential interest rate decrease due to Germany's decreasing inflation rates, economists like Deka's Ulrich Kater suggest mild interest rate cuts as a response to the softening inflation environment.
Despite wage increases outpacing consumer price developments for five consecutive quarters, consumer spending has not picked up as expected. Economist Friedrich Heinemann from the ZEW economic institute in Mannheim believes that the expectation of boosted consumption due to decreasing inflation rates might be misplaced, as service inflation continues to cause uncertainty among many people.
