German inflation drops to lowest level since start of Middle East war
The recent drop in German inflation to 2.3% year-on-year signals a stabilizing price environment, reflecting little impact from surging energy costs. Per the full note from ING, this decline, which signifies the first instance of back-to-back monthly price decreases since summer 2024, emphasizes the resilience of core inflation, holding steady at 2.5%. This backdrop comes amid expectations of potential inflation renewal in July due to the cessation of a government tax rebate on fuel, suggesting further volatility ahead.
What the desk is arguing
The desk posits that the current drop in German inflation will likely lessen upward pressure on the European Central Bank's (ECB) policy stance in the near term. This notion is buoyed by June's figures, which not only showed a decline in headline inflation but also stability in core components, indicating limited spillover effects from recent energy price hikes. Per the full note from ING, with energy, food, transportation, and various consumer goods prices all falling compared to prior months, there appears to be little immediate pressure for the ECB to act aggressively.
Additionally, with year-on-year inflation metrics in Germany revealing a noteworthy decline alongside consistent core figures, the macroeconomic landscape may foster a sense of stability for the euro. Although the justification for potential ECB tightening could emerge again in the near future, particularly with the repeal of fiscal stimulus measures impacting fuel prices, this month's data provides a conducive environment for a cautious approach.
Where it sits in our coverage
Currently, our consensus target for EUR/USD stands at 1.075 with a range from 1.04 to 1.12. Major firms like jpmorgan anticipate a level of 1.10 by March 2026, while the opposing sentiment from bofa positions their target at 1.04 for the same horizon.
This analysis aligns with traditional market expectations, leaning towards a flat or cautious ECB policy stance given the most recent inflation data. Notably, our current view is positioned slightly above the lower bound of the consensus range, highlighting a potential for strengthening if inflationary pressures remain muted.
How other firms see it
The prevailing sentiment among aligned firms, including jpmorgan and goldmansachs, emphasizes a cautious outlook on inflation dynamics, advocating for a steady or even slower tightening approach from the ECB in light of the current data. Conversely, bofa presents a contrary view, advocating a more aggressive stance on inflation from the ECB.
In this context, euro-market traders should monitor movements in the EUR/USD pair closely as it reflects sentiment driven by ECB decisions and inflation forecasts. Additionally, the interplay between German economic indicators and ECB policies could shape trajectories involving other Eurozone pairs, like EUR/CHF and EUR/GBP, offering insights into regional economic health.
How firms align with this view
Aligned with the desk view
Contrary positioning
Key takeaways
- 01German inflation decreased to 2.3% YoY, the lowest since before the Middle East conflict escalated.
- 02Core inflation remained stable at 2.5%, suggesting minimal knock-on effects from energy price fluctuations.
- 03Expectations indicate potential inflation uptick in July with the end of the fuel tax rebate.
- 04The ECB is likely to adopt a cautious approach due to the latest inflation data.
Market implications
Traders should watch the EUR/USD for potential strengthening following this inflation data as the market digests the implications for ECB policy. A breakout above 1.075 could rally sentiment towards higher targets, while additional economic signals in July concerning the fuel tax rebate will be critical to monitor.
Risks to this view
A reversal of this bullish call could arise if inflation pressures unexpectedly ramp up, particularly following the stoppage of the fuel tax rebate. Greater-than-expected impacts from energy prices on transportation and food could also force the ECB to reconsider their current stance, leading to upward adjustments in interest rates.
Older quick take Quick take 13:26 Germany German inflation drops to lowest level since start of Middle East war German inflation slowed again in June and shows very few signs of any knock-on effects from higher energy prices so far After last night, it wouldn't even be too much of a surprise if football merchandise sales were to lend a helping hand to disinflation in July Share X LinkedIn E-mail Copy link Share X LinkedIn E-mail Copy link Download Carsten Brzeski Global Head of Macro Who’s still afraid of inflation? Looking at Germany’s just-released first estimate, German headline inflation dropped in June to 2.3% year-on-year, from 2.6% YoY in May. The European inflation measure, more relevant for the European Central Bank, came in at 2.4% YoY, from 2.7% YoY in May.
What's even more important is that compared with last month, prices dropped by 0.3% – the first time since the summer of 2024 that prices dropped for two months in a row. Both core inflation and services inflation remained unchanged in June, at 2.5% YoY and 3.1% YoY, respectively. Reintroducing 'transitory' Looking at the available components, it was not only energy prices that actually dropped compared to May, but also food prices and prices for transportation, leisure, clothing and household goods.
As regards year-on-year inflation, it was mainly energy, goods and food price inflation that slowed down in June. In fact, today’s German inflation numbers provide very little evidence of any knock-on or indirect effects from higher energy prices on the rest of the economy. Looking ahead, as today marks the last day of the government’s tax rebate on fuel, inflation should accelerate again next month, even if global energy prices have come down.
Beyond the fiscal stimulus reversal, we still expect some knock-on effects from higher energy prices on transportation costs, food prices and other industrial products over the coming months. On top of that, the current heatwave in Europe clearly bears an additional inflationary risk. Lower water levels in main waterways could bring new supply chain disruptions, and damaged crops could add to food price inflation.
Looking beyond these knock-on or indirect effects, however, there is still little evidence of any self-reinforcing inflationary spiral. Selling-price expectations in both manufacturing and services have started to come down again, and with the worsening labour market, wage developments remain muted. After last night, the sales of Germany’s national football team merchandise could be another unexpected disinflationary driver in July.
Overall, German headline inflation should still accelerate to around 3.5% YoY (but nowhere near the 2022 inflation numbers) in the second half of the year, before dropping below 2% YoY again in 2027. We know that the ECB doesn’t like the term, but to us this looks pretty ‘transitory’. How a second rate hike could become a policy mistake Last night in Sintra, ECB President Christine Lagarde repeated her comments from the last press conference that the June rate hike was not an insurance hike.
Instead, according to Lagarde, it was a decision driven by an outlook of higher headline and core inflation – inflation forecasts of above 2% in 2027 and 2028, and forecasts that also had core inflation at 2.7% in early 2027. With the recent drop in energy prices, however, chances have increased that at least the headline inflation forecasts could suddenly show headline inflation below 2% in 2027. Would such a scenario stop the ECB from hiking a second time this summer?
Judging from Lagarde’s comments last night and other ECB officials in recent weeks, the answer is no. In fact, the ECB currently looks set to hike again. As long as the core inflation forecasts aren't revised downwards, there appears little in the way to stop the ECB.
Whether a second rate hike is really what the eurozone economy needs – or what an inflation outlook that increasingly lives up to the legendary ‘transitory’ really requires – remains a different story. Today, at least, German inflation data provides very little evidence of any scary indirect or knock-on effects, but could instead give rise to a new debate on the simple option of looking through a temporary energy price shock by doing nothing. Inflation Germany Eurozone ECB Content Disclaimer This publication has been prepared by ING solely for information purposes irrespective of a particular user's means, financial situation or investment objectives.
The information does not constitute investment recommendation, and nor is it investment, legal or tax advice or an offer or solicitation to purchase or sell any financial instrument. Read more Older quick take
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