“We will deliver”?
Why inflation is still so high
By Roland Lindenblatt
03/04/2023, 16:07
Despite all the efforts of politicians and monetary authorities, there is little sign of a trend reversal in consumer prices these days. Supermarket customers grumble about exorbitant prices for cucumbers and peppers. When will the prices finally go down?
Who hasn’t promised the Germans that inflation will soon fall again? ECB boss Christine Lagarde said at Deutsche Börse’s New Year’s reception: “We have to lower inflation. And we will deliver.” A few days later, Federal Economics Minister Robert Habeck even stated in a government statement: “We have broken the trend towards inflation.” That was at the end of January when both only knew the inflation rate from December 2022. At 8.1 percent, it was pleasingly lower than in November at 8.8 percent. A trend reversal, it seemed at the time.
But these days there is no sign of a trend reversal. Instead, supermarket customers grumble about cucumbers for 3.49 euros and peppers for just under 10 euros. The experts at the Federal Statistical Office also calculated average price increases of 8.7 percent for January and February compared to the same month last year. The increased interest rates from Lagarde’s ECB as well as the electricity price brake and tax cuts by the federal government should lower inflation. Why doesn’t that work?
First of all, it must be made clear that Habeck and Lagarde have already effectively combated price increases. Compared to last February, several government measures have counteracted rising energy prices: such as the abolition of the EEG surcharge for electricity, the tax reduction on gas and district heating and the electricity price brake. But despite these measures, oil, gas, electricity and the like were around 19 percent more expensive in February 2023 than in February 2022.
Inflation could fall from March
One reason why inflation is still so high are so-called second-round effects. Although energy prices have driven prices up almost exclusively, they have also made other goods more expensive to manufacture and transport. Food prices are therefore more than 20 percent above the prices of the same month last year.
But there is also slight reason for hope. So far, inflation has remained so high because when measuring inflation, the prices of the current month are always compared with those of the same month last year. In February 2022, energy prices were already higher than during the Corona period. But the big jump in prices did not come until March, after the start of the Ukraine war. If, starting in March, high prices are compared with those of the same month of the previous year, which were already high, this has a dampening effect on the inflation rate.
“Following the anniversary of the Russian invasion of Ukraine, inflation will fall more significantly from now on. In future, the current price level will be compared with the previous year’s level, which was already influenced by the outbreak of war,” confirms Friedrich Heinemann, economist at the Center for European Economic Research (ZEW). .
Inflation expectations are driving prices
In addition, the gas and heat price brakes, which work according to the same mechanism as the already active electricity price brake, will also take effect from March. The price will then be capped from March for 80 percent of consumption, for gas to 12 cents per kilowatt hour and for district heating to 9.5 cents per kilowatt hour. That, too, will depress inflation somewhat. However, a complete decline to the ECB’s two percent inflation target is still a long way off.
According to Heinemann, the downward trend, which will certainly begin in March, has little significance in terms of the long-term dynamics of inflation. After all, the trends in inflation expectations are more important. “These are still well above the pre-war level two years from now. Confidence in a price-stable future in the euro zone remains shaken.”
If people expect inflation to keep rising, then they can also demand higher wages, which in turn could tempt their employers to raise their prices. With such a wage-price spiral, inflation would become entrenched. The Bundesbank recently warned of such dynamics, only to state at the same time that things are not yet ready in Germany.
Monetary policy appears to be working
The big sister of the Bundesbank, the ECB, on the other hand, is already expecting falling inflation. ECB chief economist Philip Lane said in an interview with Reuters news agency on Tuesday: “Retail prices for goods are still very high. But precursors have been a good indicator of price pressure so far. The fact that they are getting cheaper, partly because easing supply shortages suggests that the rate of inflation for energy, food and goods will fall significantly.”
He also sees the first effects of the higher key interest rates of the ECB. We are already seeing a significant increase in lending rates, a fall in real estate prices and higher lending rates, all of which are causing demand for energy and other commodities to fall.
In short: price pressures are falling while government aid is increasing. A good sign, although it could take some time before inflation approaches the two percent target again.