(Macoreconomics) German inflation unexpectedly soars, heaping pressure on ECB

• Consumer prices jumped 11.6% in October; median est. 10.9%
• Data also came in above analyst estimates in Italy and France

German inflation unexpectedly accelerated this month, following a trend already seen in France and Italy that will increase pressure on the European Central Bank to raise interest rates even as a recession looms.

Consumer prices in Europe’s largest economy rose 11.6% from a year earlier -- far exceeding all estimates in a Bloomberg survey whose median forecast was 10.9%. Comparable rates were last recorded in the early 1950s in West Germany.

Inflation in Italy, meanwhile, surged to 12.8% -- way ahead of all estimates. France surpassed expectations, too, with a 7.1% advance. Spain was the only major euro-area nation to see price pressures ease. Data for the 19-nation bloc are due Monday.

The figures are likely to feed the ECB’s enthusiasm to confront inflation that’s five times its 2% target. Officials on Thursday doubled their main rate to 1.5%, the highest in more than a decade. But with Europe at risk of a recession, the ECB dropped an earlier reference to rate increases continuing for “several meetings,” saying simply it expect borrowing costs to be raised “further.”

Money markets pared wagers on monetary tightening after the decision, even as President Christine Lagarde told journalists that there’s still “ground to cover.”

Traders reversed some of those trades on Friday following the inflation data and comments from ECB officials, betting the central bank’s key rate will peak at around 2.85% in 2023, up from about 2.65% at Thursday’s close.

Several ECB rate setters spoke out in favor of more forceful action when policymakers gather for a final time this year to decide on borrowing costs in December. Lithuanian central bank chief Gediminas Simkus, for one, said the ECB’s next move must be “substantial,” though France’s Francois Villeroy de Galhau said there’s no obligation to maintain the 75 basis-point increases delivered at the last two meetings.

The ECB may take encouragement from Germany unexpectedly avoiding an economic contraction in the third quarter. But while that should keep the euro zone as a whole growing during that same period, a downturn driven by inflation and the energy crisis looks all but inevitable this winter.

Volkswagen is struggling with cost pressures due to supply-chain problems and has fallen short of profit expectations, predicting deliveries this year will stagnate instead of growing by 10%. Covestro AG, a maker of polymers and high-performance plastics, cut its guidance this week after higher energy costs and weak orders sent income tumbling.

The Bundesbank sees German output shrinking “considerably” this winter, and ECB President Christine Lagarde has said the Governing Council isn’t oblivious to the risk of a slump in the wider euro zone.

The article discusses the ongoing increasing inflation in germany and the threats that this inflation lays out for the consumers, traders and economy of the country. With an increase in consumer price of 11.6% the country can be negatively affected and in response the country will draw itself into an inflation position causing the government to apply necessary measures. Through the increasing inflation it can lead to an unsustainable impacts on the economy leading to a need for change.

Inflation signifies the weakening purchasing power as price increases and money can only purchase a fewer amount of goods and services, hence widely depicting the rapid increase in consumer prices. Moreover, this also means that there is a decrease in the consumer confidence and greater uncertainties as businesses and firms reduce investments, which can be observed as traders overturned the trades they made after the release of the inflation data in germany. These reduced investments further slow down the economic growth. This also means that the production of goods and services cost increases, thus this can be considered as a cost-push inflation. Inflation in the economy can be visualised through the figure 1 below.

Figure 1 represents the graph depicting the cost-push inflation and the change in aggregate supply in the german economy through neoclassical perspective. The fall in aggregate supply due to increased production costs or wages or a sharp disruption in the availability of factors of production wages leads to a cost-push inflation in the economy. At this point the price level increases from P₁ to P₂ and the real output decreases, showing the change in price level. The economy from equilibrium A moves to a new equilibrium B with a higher price level and lower real output as the SRAS curve shifts left. As given in the article, volkswagen is facing problems with supply-chain as there is an increase cost pressures. Hence, this means that this requires change in the economy there must be a monetary policy implemented in order to fix this inflation.

Monetary Policy includes the actions taken by the central bank of a particular country in order to manage the supply and the cost of money in the economy, which here is the german economy. This policy targets to reach the macroeconomic objectives like economic growth, price stability and sustainability to bring change in the economy. In this article of the german economy, the policy which needs to be implemented to reduce inflation is contractionary monetary policy. Moreover, the german central bank “Deutsche Bundesbank”, aims to avoid economic contraction after the implementation of this policy. When an economic contraction occurs businesses and firms might experience a decrease in demand for their goods and services, leading to a reduction in the revenue generated. To avoid losing out on these profits, businesses cut wages, decrease the quality/quantity of the product or increase the price level. These costs passed on to consumers in the form of higher prices leads to a cost-push inflation. The reason behind this that instead of the demand increasing as the cost of productions increase for the goods and services, the prices of these goods and services are increasing. Thus, this signals the german government to avoid this cycle of moving towards a cost-push inflation, hence avoid an economic contraction.

However, contractionary monetary policy also has a few backlags along with it which might cause the economy to change in a negative manner. As interest rates rise, consumers and businesses invest and spend less, thus resulting in a decreased economic growth. This policy also leads to an increase in unemployment since business proceed to hire less people and as businesses receive less profits, it can also lead to layoffs. Furthermore, the policy also means that it would increase borrowing costs for the government leading higher interest rates on payments on government debts which puts the governments finances in jeopardy. These policies can have spillover effect on other economies, especially economies which play a major role in the financial markets. This can lead to a decrease in competitiveness and economic imbalance and a change in the functioning of the economies across the globe. Nevertheless, this policy can be very efficient in decreasing the cost-push inflation in the economy. It is essential for the central bank to carefully monitor the potential negative impacts and make decisions likewise.

“German Inflation at Highest Level in More than 25 Years.” The Economic Times, https://economictimes.indiatimes.com/news/international/business/german-inflation-at-highest-le vel-in-more-than-25-years/articleshow/94542362.cms?from=mdr.