German Inflation Rises

The German inflation rate as measured by the HICP accelerated to 8.4% in July from 8.3% in June; this gain is still short of the peak pace of 8.8% in May. The core rate moved up sharply to log a 12-month gain of 4.6% from 4.2% a month ago; it is also short of its peak rise of 4.7%, also in May. Still, these are high rates of inflation and well above the target for all the European Monetary Area, a target of around 2% since the new objective for the ECB is an average of 2%.

The month-to-month change in the July HICP was a gain of 0.6%, a sharp turnaround from June’s 0.2% drop. The core rate also rose by 0.6% in July, also sharply higher than its 0.3% decline in June. Both the headline and the core measures had risen sharply in May with the headline up 1.1% month-to-month and the core up 0.8% month-to-month. What we learn by looking at the monthly values is not much. May saw a terrific spike, June gave us some relief from that spike, but now in July inflation is back running hot – even as energy prices cooled a bit.

The German domestic measure of inflation has tracked the same changes as the overall HICP. The headline rose by 0.5% in July after falling by 0.2% in June and currently shows a 7.6% increase year-over-year. The CPI excluding energy for the domestic inflation measure shows a 0.6% rise in July after falling by 0.3% in June; it is up by 4.4% year-over-year (a bit less than the core for the HICP measure).

Over the 11 categories in the table, inflation is accelerating in 59% of them in July. This is a sharp pickup in diffusion from June and May when inflation was accelerating and only 27% of the categories and 18%, respectively.

However, the sequential diffusion readings are much more worrisome. Over three months inflation diffusion is 63.6%, over six months it’s at 72.7%, and over 12 months it's 54.5%. The diffusion calculations represent the percentage of the categories with inflation rising and half of the categories with inflation unchanged; a value of 50% is neutral in terms of inflation acceleration and deceleration. Values higher than 50% indicate inflation is accelerating; values below 50% indicate a deceleration. Of course, the actual inflation figure for the month may not behave this way because the inflation statistics are weighted. The diffusion statistics are not weighted; they're just applied across categories.

Even though headline inflation is up sharply over 12 months at 8.4% compared to 3.2% a year ago, the diffusion calculation on that comparison is only at 54.5%, just a small measure above the 50% acceleration guideline. Setting aside the issue of the weighting the categories, one of the reasons that the diffusion indexes is low while inflation itself accelerates sharply over 12 months is that among the categories that see price increases the acceleration averages about five percentage points whereas among the categories where inflation decreases, the decelerations average only about two percentage points. But the diffusion calculation is about the number of categories that are moving not about magnitudes. So, with six categories accelerating and five decelerating, the accelerators win and we get a diffusion reading slightly above 50%. But in terms of the inflation number, we get a much higher inflation number than this diffusion calculation would suggest because where inflation is accelerating it's accelerating sharply and where inflation is decelerating it's decelerating at about half the pace of its acceleration. This, of course, is in addition to the differences in weighting across the categories. Diffusion is a useful metric we see it used in the PMI reports, for example. But it also has some limitations. One thing it is good for is assessing inflation’s breadth. As of July, over six months and three months, inflation is rising both strongly and broadly.

Oil prices were factor tending to move inflation lower in July. Brent oil prices expressed in euros had risen by 7.6% month-to-month in May and by 5.3% month-to-month in June, but in July those prices fell by 7.3%. Sequentially, Brent prices have slowed down as well. Brent rises at a 21.6% annual rate over three months, at an 85.9% annual rate over six months and at a 64.1% annual rate over 12 months. This compares to a rise of 66.9% year-over-year one year ago. The break in Brent prices should help to pave the way for milder inflation in the future if global oil prices continue to trade in this lower range or lower.

The bottom line for Germany is that inflation is still far too strong. The ECB is raising rates, but it is also worried about fragmentation in the euro area and the threat of an energy cut off from the Russian pipeline that would cripple most of Europe. Russia has reduced the oil flow already using what many regard as a bogus maintenance excuse. Inflation is clearly too high in the EMU; it continues to cook at a torrid pace in Germany and in Europe and yet the ECB finds its hand is stayed by concerns about how geopolitical and economic risks interact in the euro area. It's a tricky situation all around and inflation is still far too high.