Dilemma for ECB as German inflation hits five-year high

Monday, 1 January 2018 00:00 - - {{hitsCtrl.values.hits}}

BERLIN (Reuters): German inflation hit its highest level in five years in 2017, initial data showed on Friday, sowing the seeds of more discord among rate setters at the European Central Bank, where some policymakers want to stop pouring money into the euro zone.

European Union flags flutter outside the European Central Bank (ECB) headquarters in Frankfurt, Germany December 14, 2017 - REUTERS

Consumer prices harmonised to make them compatible with inflation data in other European Union countries rose by 1.6% year-on-year in December, compared to the 1.4% forecast by analysts polled by Reuters.

“This is the correction to the inflation course desired by the ECB,” said Alexander Krueger of Bankhaus Lampe. “And it is sustainable.” On the month, prices in Europe’s largest economy rose by 0.8% compared to November, faster than the 0.6% increase expected by analysts. German inflation figures are closely watched because of their influence on the ECB’s monetary policy.

The central bank earlier this month stuck to its pledge to keep injecting funds into the euro zone despite opposition from rate setters who point to increased growth and inflation forecasts for the single currency as reasons to change course.

German prices rose an average 1.7% over the year in harmonised terms, the largest increase since 2012, when inflation hit 2.1%.

High food costs made the largest contribution to the headline price increases, data released by the Federal Statistics Office showed, followed by increased rents.

The ECB’s governing council holds a monetary policy meeting on Jan. 25.

The German data will give hawkish members like Dutch central bank governor Klaas Knot more arguments in favour of unwinding the ECB’s 2.55 trillion euro ($3.06 trillion) bond-buying programme. The German economy is firing on all cylinders with both consumption and exports providing impulses this year, unfazed by political uncertainty created by Chancellor Angela Merkel’s failure to form a government after an election in September.

Some economists say the ECB’s low interest rate environment risks causing the German economy to overheat. The ECB says its policy is tailored for all 19 member states that use the euro.

Merkel’s conservatives, who in January will launch talks with the centre-left Social Democrats on renewing a coalition that has ruled Germany since 2013, have promised to cut taxes.

The Ifo economic institute warned on Friday that tax cuts would raise the risk of overheating as consumers will have more money to spend, providing even more fuel to the German economic engine. “Tax cuts would at this point in time have a pro-cyclical effect,” Ifo economist Timo Wollmerschaeuser told Spiegel magazine. “This will fuel the boom even further.”

He said the next government should raise taxes to dampen consumption and provide some cooling for the economy, which would have a similar effect to an ECB rate hike that is unlikely to come any time soon.

The German government has lifted its growth forecasts, projecting the economy to grow by 2% this year and 1.9% in 2018. The Bundesbank expects growth of 2.5% next year.