Inflation’s Downturn in Germany Slows or Stops- Are We ‘There’ Yet?

What Are Central Bankers Thinking about Inflation?

The focus on inflation and its implication for central bank policy has become a very widespread sport, especially now that inflation rates have declined substantially from their peak and have come much closer to central banks targets (2% all around). Lower inflation rates have taken some of the ‘air out of the inflation ball’ and the call-to-arms to maintain high rates. But that ball is still in-play and inflation is still excessive in most places, Germany, the EMU, the United States, the United Kingdom…just to name a few.

However, with elections on the boil in the U.K. and on the horizon in the U.S., decisions to change interest rates begin to leave the economic spectrum and enter the twilight-zone of the political world, one of very different dimensions. Or maybe we’ve reached the outer-limits…hard to tell.

The Bank of England met today and did not change rates with a 7-2 vote. But we are told three members were ‘on the fence.’ Had they shifted to a rate cut mode the vote to approve a cut would have gone 5-4 in favor. We are now told if things go as planned, an August cut is possible (likely, according to some). Many headlines about the BOE decision today note that the BOE did not cut rates even though inflation has been falling. Well, the data show roughly 2.9% headline inflation in the U.K.; core measures coalesce around 4.4% to 3.9%. These all are above target, but the financial press is not mindful of that. This is the sort of reporting that we have become used to in the U.S. as well.

Is all policy now derivative...or based on derivatives? Apparently, we have crossed some barrier and no longer live in a world where inflation levels or actual price levels matter! But changes matter. We live in derivative land! Biden supporters tout the drop of the inflation rate as do BOE-bashers. They neglect to mention that the level of inflation is still over target, and the rate of decline in inflation’s pace has slowed… or worse. No one is interested in targets anymore. In the U.S., where inflation has made prices high, people say yes, prices are high, but inflation is much lower- as though I can buy goods for the inflation rate instead of at the price level. Sheese…

What I see in progress in the U.S., the U.K., and the EMU is that policy decisions are longing to be made and looking for the right argument to justify them. This is not what should happen-this is backwards. Economics first, policy result, second. But economics has been captured by politics and the emerging view that no one ever need suffer if policy is just fine tuned correctly, as that great economist Steven Tyler wrote…’Dream on.’

Germany’s PPI dilemma So, the German case here with the PPI looks at an indicator but not the one with most skin in the game (the CPI/HICP). This is the PPI, a more volatile less comprehensive index. But we include in the table German CPI trends (CPI and CPI ex-energy) and see that inflation is above 2% and stuck sequentially. In any event, the ECB makes monetary policy for the Monetary Union and Germany is only a portion of that. But as the Union’s largest economy, what happens in Germany matters. And since Germany is not Las Vegas, what happens in Germany does not necessarily stay in Germany. The CPI is ‘stuck,’ and the PPI is accelerating.

German PPI inflation is transiting (overall and ex-energy) to higher inflation rates from 12-months to 6-months to 3-months. Will that sequence spread?

What lies ahead? There is no telling where all this goes. We live in a different age than the one where I learned about monetary policy. Nothing I know about monetary policy would have me on the verge of cutting rates now, in the U.K. or in the U.S. – and likely not in the EMU either. Policy apparently operates on the idea that we can run policies that are for gain no pain- a new idea! I fear this is going to be a quick gain, with delayed pain (circa 1970s in the U.S.). But as that suggests, only time will tell. German inflation pressures have not gone away. The ECB has executed one rate cut and the prospect for another is up in the air. The rate cut vultures are circling the BOE, spiraling down like the dementors in Harry Potter. But there is no ‘expecto-petronum’ escape clause for a central banker.

Can central banks really expunge inflation at low cost? No downturn? Little or no rise in unemployment? Or will these goals prove to be a fool’s errand? Already in the U.S. the soft-landing-seeking policy of ‘higher for longer’ is putting a long-squeeze on the housing industry and stepping up fiscal debt interest payments for an increasing portion of the debt. These things do not need to happen- but they are the collateral damage from seeking to avoid a recession. Fortunately, inflation is only looking stuck, and it is not accelerating to any great extent. Any force of acceleration we identify is muted and only serves to keep inflation from reaching target for now. But rate cuts would introduce a new factor, a new risk - stimulus!

Central banks look for maximize GNP I argue for close-watching of this ‘new monetary experiment’ in action. Call it GNP: Gain No Pain. It’s in vogue. ‘Everyone’ is doing it. And you know that does not make it right. At one time ‘everyone’ in the U.S. was underwriting sub-prime mortgages, too. There may be safety in numbers but often there is no wisdom (the Madness of Crowds). I did not realize that monetary theory went in and out of fashion like the length of skirts and width of men’s ties…I know what you are thinking...what’s a tie? Times change. Good luck!