Inflationary pressures are fading as German headline inflation came in at 2.8% year-on-year in October, from 3.3% YoY in September. This is not only a tax rebate story, but also a broader-based retreat of inflationary pressures as both core and services inflation also fell. Core inflation fell to 2.1% YoY, from 2.4% YoY in September.
Still no signs of knock-on effects from higher energy prices
Looking at the available components at the regional state level, there are still no signs of any indirect effects from higher energy prices on the rest of the economy. All measures of underlying inflation dropped in October, including the often-discussed services inflation.
In fact, household energy prices fell month-on-month, probably reflecting the government’s fuel tax rebate. Meanwhile, weak final demand is evident in falling prices for household goods and leisure, which have now declined for two consecutive months.
Comforting signal for ECB doves
Looking ahead, the path of headline inflation remains highly affected by the war in the Middle East and oil prices. On top of this, the start of the winter heating season, combined with low gas storage levels, is also likely to push up gas prices in the coming weeks, translating into higher retail prices at the start of next year. As a result, we expect headline inflation to increase again and remain above 3% towards the end of the year and in early 2027. 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. Despite a recent increase, selling price expectations in services and manufacturing remain below their April and May levels. 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.
For the ECB, today’s German inflation data will comfort the doves as the numbers show that there are still no indirect or second-round effects in sight. If this situation remains unchanged, even a December rate hike might not be a done deal, yet. For the ECB to continue on what ECB President Christine Lagarde yesterday called ‘the direction of travel is clear’, some knock-on effects from higher energy prices would be useful.
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