Things had been declining almost throughout 2023, but at the end there was now a turnaround: According to the Federal Statistical Office on Thursday, the inflation rate rose again in December 2023, from 3.2 to 3.7 percent. For the whole of 2023, the statisticians estimated the price increase rate at 5.9 percent.
These numbers themselves are no cause for panic; the recent increase in particular was expected and is primarily due to statistical base effects. However, economists are worried about something else: the core inflation rate. It reflects the long-term underlying trend. And there is still no reason to give the all-clear. However, this could destroy the financial market’s hopes of interest rate cuts soon.
A key reason for the renewed increase in the inflation rate occurred a year earlier, in December 2022. At that time, the federal government had paid the so-called “December emergency aid”, i.e. it had paid private households’ monthly deductions for gas and heat as a one-off payment.
Source: Infographic WELT
At that time, this cost item had statistically fallen to zero, and accordingly the mark-up is even stronger now that the costs from December 2023 are compared with December 2022. Specifically, a 4.5 percent decrease in energy prices in November 2023 turned into an increase of 4.1 percent in December.
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When it comes to food, however – another key cost driver in the past two years – the inflation rate fell further, from 5.5 to 4.5 percent.
If you exclude developments in energy and food, you get so-called core inflation. Both economists and the monetary authorities at the European Central Bank look at these, because the basic trend can be seen from them.
Core inflation rate is falling very slowly
The good news: The core inflation rate fell again, from 3.8 to 3.5 percent. The bad news: This is still a decline in triple steps, and the value is still a long way from the central bank’s target of two percent. “The price trends in core inflation show ongoing price pressure across the economy,” says Michael Heise, chief economist at asset manager HQ Trust.
Above all, this price pressure is unlikely to ease in the coming months. “Numerous government measures will significantly increase prices,” says Heise. Energy prices are likely to increase in January, as the CO₂ price rose more than originally planned from 30 euros per ton to 45 euros.
In addition, the price brake for gas and electricity expired at the turn of the year. Furthermore, gas and district heating customers will again pay the full VAT of 19 percent instead of the reduced seven percent. It also returns to the old level of 19 percent for meals in restaurants.
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Jörg Krämer, chief economist at Commerzbank, expects that all of this will have an effect of around 1.2 percent, so the January inflation rate is likely to be correspondingly higher.
He assumes that it will then fall again. “In the end, inflation is likely to settle at three percent rather than two percent because wages are rising sharply,” he says.
In addition, the increased levels resulting from government surcharges create a statistical effect throughout the year that increases the inflation rate. This in turn could pave the way for further, even higher wage demands from the unions – the inflation spiral would turn faster again. “The inflation problem has not yet been solved,” says Krämer.
Source: Infographic WELT
“It is foreseeable that the inflation rate will receive a new boost at the beginning of the year due to government price gouging,” says Alexander Krüger, chief economist at the private bank Hauck Aufhäuser Lamp. Values of less than three percent in February are now unlikely. “In addition, the number of companies that want to raise prices is currently increasing,” he mentions as another influencing factor that should not be lost sight of.
Michael Herzum, head of economics and macro strategy at Union Investment, is somewhat more optimistic. He expects core inflation to fall further to 2.5 percent as the year progresses.
Sebastian Dullien, director of the union-affiliated IMK Institute, also believes that the downward trend in inflation will begin again in February and that it will then move towards two percent over the course of the year. “For the whole of 2024, we expect an average inflation of 2.5 percent,” he says.
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Effects of Inflation
The problem: This is still well above the ECB’s target – and that could have consequences for the development of key interest rates and thus also for the stock markets. In the past two months, the financial markets have become convinced that the central banks will very soon cut interest rates again.
Investors recently saw the probability of this happening in the first quarter of 2024 at just under 90 percent for the US Federal Reserve and around 60 percent for the European Central Bank. This can be seen from trading interest rate futures.
This prospect has led to a rally in the stock markets since the end of October, particularly in those stocks that tend to benefit from lower interest rates, such as small caps, technology stocks and companies with high levels of debt.
Source: Infographic WELT
However, these hopes could now be disappointed. “The December inflation figures are sobering for consumers and central banks,” says Michael Heise. “It is unlikely that the ECB will cut interest rates in the near future.”
Michael Herzum also believes that it will take longer than expected for the central banks to take action. “We believe the market’s expectations of rapid interest rate cuts are premature,” he says. “We expect the first interest rate cut in June.”
In fact, the yields on German government bonds had already risen significantly on Thursday morning after the first inflation data from individual federal states became known and showed significantly higher rates of increase. And the stock market was recently unable to continue its rally that had lasted since October.
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