Rising fuel prices push German inflation towards three-year high
The recent increase in German inflation, driven by rising fuel prices, has reached a three-year high, signaling challenges for the European Central Bank's (ECB) monetary policy. Per the full note from ing-think, inflation jumped to 3.3% year-on-year in September, reflecting a significant rise from 2.9% in August and nearing the December 2023 peak of 3.8%. Despite this headline increase, core inflation remained stable at 2.4%, suggesting that higher energy prices have not generated widespread inflationary pressures throughout the economy, a key consideration for ECB policy. The desk believes that as long as core inflation stays contained, further monetary tightening may be viewed skeptically by some ECB members, particularly in light of other price segments such as leisure and healthcare showing declines.
What the desk is arguing
The desk posits that the rise in German inflation is predominantly an energy-related issue, signaling a nuanced economic landscape for policymakers. According to ing-think, the upswing in consumer prices is concentrated in the energy sector, leaving core inflation metrics untroubled. This dynamic suggests that while headline inflation raises eyebrows, the ECB may opt for caution regarding rate hikes in the face of subdued core metrics.
Supporting the desk's thesis is the observation that overall inflation is projected to remain between 3% and 4% until early next year, influenced by geopolitical factors such as the ongoing Middle East conflict. However, given that core inflation stays put, additional rate hikes could be seen as unnecessary amid improving economic signals in other sectors.
The alternative read, which assumes broad inflationary pressures beyond energy, might lead to a more aggressive stance from the ECB, but current numbers are not supporting that narrative.
Where it sits in our coverage
Our consensus target for EUR/USD currently sits at 1.075, with a range between 1.04 and 1.12. Notable firm targets include: - jpmorgan: 1.10 (Mar26) - bofa: 1.04 (Mar26)
The desk's outlook reflects a moderate stance that aligns closer to jpmorgan's target, sitting within the upper part of the range addressed by our coverage.
How other firms see it
Several firms share a view aligned with the desk, suggesting a muted response from the ECB. Firms like jpmorgan are more optimistic about inflation stabilization, while bofa presents a contrary stance, foreshadowing potential rate adjustments based on broad inflation indicators.
Given this, the EUR/USD currency pair is influenced by ECB monetary decisions and inflation metrics as key indicators. Observing EUR/USD will be essential as it reflects the broader sentiment on the ECB's policy trajectory and inflation outlook.
How firms align with this view
Aligned with the desk view
Contrary positioning
Key takeaways
- 01German inflation reached 3.3% YoY in September, fueled by rising energy costs.
- 02Core inflation remained steady at 2.4%, indicating limited spillover effects from energy prices.
- 03The ECB may slow down rate hikes due to subdued core inflation despite headline numbers.
- 04Inflation is expected to fluctuate between 3% and 4% until early next year, influenced by geopolitical events.
Market implications
Market participants should monitor the EUR/USD exchange rate closely as inflation data evolves, especially for thresholds around 1.075 which align with our consensus target. Any unexpected movements in core inflation could prompt shifts in market positioning ahead of ECB meetings.
Risks to this view
The primary risk to this outlook is a sudden uptick in core inflation metrics, which could lead to a reassessment of ECB policy and trigger a more aggressive interest rate trajectory. Additionally, a sharp rise in energy prices due to escalated geopolitical tensions could catalyze further inflation concerns.
Older quick take Quick take Published 13:20 Germany Rising fuel prices push German inflation towards three-year high German headline inflation has surged to its highest level since December 2023. But the data also sends a clear message to the ECB: there are currently no knock-on effects from higher energy prices on the rest of the economy German inflation has picked up, and is expected to stay above 3% until early next year German headline inflation is almost at a three-year high, coming in at 3.3% year-on-year in September, from 2.9% YoY in August. In December 2023, headline inflation stood at 3.8% YoY.
The European inflation measure, more relevant to the European Central Bank, also came in at 3.3% YoY. While at face value these inflation numbers are a clear concern for the European Central Bank, the fact that core inflation remained unchanged at 2.4% YoY and services inflation even drifted lower to 2.7% YoY from 2.8% YoY in August shows that inflation currently remains an energy price phenomenon. As long as core inflation remains subdued, some ECB members might question the need for further hikes.
Inflation still mainly an energy story Looking at the available components at the regional state level, the September surge in inflation remains mainly the result of higher energy prices. There were very few signs of knock-on or indirect effects of higher energy prices on the rest of the economy. The only visible knock-on effects are currently in the transportation sector, which are probably also driven by the effects of low water levels in main rivers.
For the rest, prices for leisure activities, household goods and healthcare actually dropped in September, providing more evidence of weakening demand rather than broadening inflationary pressures. Inflation to remain between 3% and 4% Looking ahead, the path of headline inflation remains highly affected by the war in the Middle East and oil prices. In our base case scenario, we are still assuming that the war will continue and relief will only come after the US mid-term elections.
Against this backdrop, headline inflation will remain above 3% at least until early 2027. Low gas storage levels are likely to lead to higher gas prices over the coming weeks, translating into higher retail prices at the start of next year. In fact, at the end of September, storage levels at less than 60% are historically low for this time of the year and also clearly below the level seen during the energy crisis in 2022.
Together with some knock-on effects from higher energy prices on transportation costs, as well as the inflationary impact of the drought on food prices and other industrial products, it could now take until the end of 2027 before headline inflation drops below 2% again. As worrisome as this might sound, the current inflation picture remains structurally different from the inflation wave in 2022. Selling price expectations in services remain below pre-war levels and only recently crawled up again in manufacturing.
At the same time, consumers’ willingness and also financial ability to pay higher prices are much lower than in 2022. As a result, it will be hard for companies to pass through higher production costs. Instead, margin squeezing will be the only game in town.
The ECB's dilemma is worsening For the ECB, today’s German inflation data is actually worsening its ongoing dilemma: how to react to a supply-side shock driven by surging energy prices that has so far produced only limited knock-on effects across the broader economy, set against still-fresh memories of the 2022 inflation surge and delayed central bank responses. And all of this is accompanied by resilience within the eurozone economy that almost seems too good to be true. Even if the central bank doesn't like the term, an expected ECB hike in December would still fall into the category of an “insurance rate hike”; the damage of executing it would be lower than not acting.
However, the more insurance rate hikes the ECB opts for, the higher the risk that it creates an unwarranted accident in the economy or financial markets. In fact, as long as there is only a very limited spreading of the energy price shock to the rest of the economy, there is very little reason for the ECB to continue hiking next year. Every additional rate hike increases the risk of an unwarranted slowdown of the economy.
If we are right and oil prices come down towards the end of this year and knock-on effects from higher energy prices remain limited, we don’t see additional rate hikes in 2027. If we are wrong, the story could clearly change. Monetary Policy 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 Share X LinkedIn E-mail Copy link Share X LinkedIn E-mail Copy link Download Author Carsten Brzeski Global Head of Macro Older quick take
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