German inflation in December came in slightly lower than anticipated, signaling a more modest increase in energy costs. This outcome may help keep wage demands in check and provide a faster path towards the European Central Bank's (ECB) inflation target of 2%. According to the German statistics office, consumer prices rose by 3.8% annually, falling short of economists' predictions of 3.9%. While this is an increase from November's inflation rate of 2.3%, it is worth noting that the reading for the entirety of 2023 stood at 6%.
The recent surge in inflation can be attributed to base effects. State aid for natural gas and district heating bills in 2022 resulted in suppressed energy costs, leading to a boost in inflation a year later. However, recent data suggests that prices for electricity, gas, and fuels have declined, with regional German figures indicating a continuation of this trend in December.
This trend is also evident in neighboring France, where inflation rose to 4.1% from 3.9% due to the withdrawal of government assistance. Ireland experienced a faster rise in prices, while Spain reported steady inflation at 3.3% last week.
While Eurozone inflation is expected to rebound to 3% in the upcoming figures due on Friday, the slowdown that began in November 2022 is predicted to recommence throughout the year.
The ECB remains cautious about inflation. President Christine Lagarde and her colleagues are closely monitoring domestic factors, particularly wage growth. Negotiations for new wage agreements for around half of the workers covered by the ECB’s wage tracker will take place in the first half of 2024. The outcome of these negotiations will play a significant role in shaping the path of interest rates.
Money markets are currently indicating a likelihood of approximately six interest rate cuts by the end of the year. However, even the more hawkish members of the ECB's Governing Council have voiced their opinion that rates are unlikely to increase further, unless there are additional shocks. Thus, they have pushed back against the notion of near-term interest rate cuts.
In a recent interview, Bundesbank President Joachim Nagel advised traders speculating on an imminent reduction in borrowing costs to exercise caution, citing past misjudgments by others.
The sluggish Eurozone economy may contribute to the retreat in inflation, with indications that the bloc may have experienced a mild recession in the second half of 2023. Furthermore, Germany is showing limited signs of a strong rebound to follow.
While the ECB's recent projections suggest that inflation will return to 2% in the second half of 2025, the Bundesbank does not anticipate Germany reaching this milestone before 2027. Bloomberg Economics' current forecast points to an inflation reading of 3.1% for this month.
Experts believe that the ECB will remain cautious in its approach to inflation. They expect that by the second quarter, and in their next set of forecasts to be released in June, the ECB will signal a clearer path towards achieving their inflation target within their time horizon. It is possible that they may even reach the target a little earlier, but a more cautious approach from the ECB is anticipated, suggesting a potential rate cut in the second quarter.