German inflation continues to decline – economy

The inflation in Germany continues to fall. In February, the inflation rate was 2.5 percent, as the Federal Statistical Office announced in an estimate on Thursday. Inflation last fell to 2.9 percent in January, its lowest level since June 2021. The decreasing price pressure is a result of the significantly lower energy prices compared to the same month last year. This so-called base effect should subside over the course of the year – meaning that the inflation rate will fall less sharply in the future.

In 2023 as a whole, annual inflation was 5.9 percent, less than 6.9 percent in 2022. But it was still the second highest annual figure since reunification. The increase in the CO₂ price from 30 euros per tonne of carbon dioxide to 45 euros and the reset of the regular VAT rate on food in restaurants will create fresh price pressure in 2024.

As the largest economy in the Eurozone, the German inflation rate has a strong influence on the overall rate in the monetary union. In France, inflation was 3.1 percent in February and in Spain it was 2.9 percent. In January, inflation across the eurozone was 2.8 percent. For comparison: in autumn 2022 the value was over ten percent. The current figures for the entire monetary union will be published on Friday. The ECB is aiming for an inflation rate of exactly two percent in the medium term.

Due to the sharp price increases, the central bankers have raised interest rates ten times in a row since July 2022, most recently in September 2023. Since then, the main refinancing rate at which banks can obtain fresh money from the central bank has been 4.5 percent. The so-called deposit rate, with which the central bank pays interest on surplus funds from commercial banks, is at four percent – this is the highest level in the history of the monetary union. Public pressure to lower key interest rates again is growing. But most central bankers are cautious, even though the high key interest rates are now having the desired effect.

Germany is suffering the most economically

Banks are granting fewer loans because companies and consumers are afraid of the high interest costs. The real estate markets have cooled noticeably, especially in the commercial sector. Germany is suffering the most economically, but growth prospects in the Eurozone as a whole are also rather poor. The effect is desirable: the central bank’s tight interest rate policy is intended to cool the economy. Declining demand, the thinking goes, reduces price pressure. The question is how much the economy should be cooled down in order to rule out a resurgence of high inflation rates.

“In previous interest rate cycles, waiting was always a better approach than reacting too early. It would be fatal if we cut interest rates too early and then inflation comes back again,” said Bundesbank President Joachim Nagel in an interview with the news agency Reuters. That is also a question of credibility. According to Nagel, the ECB is on the right track: “I am confident that the inflation issue will be resolved by 2025.” The next ECB interest rate meeting is on March 7th, and the experts believe that the interest rate screw will not be turned. The financial markets believe that the first interest rate cut in April is possible. Others are looking ahead to the June meeting, when key pay data will be available.

The unemployment rate in the monetary union is at its lowest level in its history

“Wage pressure remains strong,” ECB President Christine Lagarde told the European Parliament this week. “Wage growth is expected to become an increasingly important driver of inflation dynamics in the coming quarters.” This would reflect employees’ demands for inflation compensation as well as the tense labor markets.

The unemployment rate in the monetary union is at its lowest level in its history. Therefore, unions can enforce high wages. In Germany, wage growth is slowly becoming noticeable. Real wages grew by an average of 0.1 percent compared to 2022, as the Federal Statistical Office announced on Thursday. According to this, wages rose by 6.0 percent, the fastest they have been since 2008. But in real terms there was hardly anything left because consumer prices rose almost as strongly, at 5.9 percent. However, according to experts, there is a good chance that employees will have significantly more in their wallets by 2024. “We should see the strongest increase in real wages this year since 2015,” said ING chief economist Carsten Brzeski. “With an inflation rate of around three percent and nominal wage growth of four to five percent, good times are ahead for employees.”

Central bankers see it differently: “Without the strong wage increases, the easing of monetary policy could already begin,” says Belgian central bank chief Pierre Wunsch. Some monetary authorities warn of the danger of a wage-price spiral. That would mean: Companies add labor costs to prices, which in turn triggers new wage demands – even though the high key interest rates are definitely having an effect. At the moment it doesn’t look like this, at least in this country: According to the Munich Ifo Institute, fewer companies in Germany are planning to increase their prices. “Inflation is therefore likely to continue its decline in the coming months,” said Ifo economics chief Timo Wollmershäuser.