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Inflation in Germany eases slightly

Mon, Aug 25 2008, 06:20 GMT
by BHF-Bank Economics Department

BHF-Bank

Highlights

• US banks still in the spotlight – Fannie and Freddie to be nationalized?

• ifo unlikely to have deteriorated further in August

Economic signals in the run-up to ECB meeting

After the US dollar’s sharp rebound in the first half of August, a moderate counter-movement began a few days ago. EUR-USD recovered from about 1.46 at the start of the week to around 1.4840. The yen made similar gains: USD-JPY fell from 110.50 to just over 109. The highest gains – well over two per cent during the course of the week – were made by the Eastern European currencies, which had previously posted the highest losses. In contrast, the Swiss franc, and the pound Sterling in particular, only made a relatively weak recovery.

The dollar’s rally had been mainly due to the sharp deterioration in the economic outlook in the rest of the world, particularly the eurozone and other EU countries, but also Japan. The sustained economic problems in the US seemed to have faded slightly into the background at that point, given that real GDP growth turned out to have been relatively strong in Q2, the manufacturing sector still looked quite robust (due to foreign demand), and falling commodity prices had had a positive impact on equity markets.

This week, however, the problems came to the fore again. The former IMF chief economist caused a stir by saying that some larger US banks could collapse and that the worst of the financial crisis was still to come. On top of that, Fannie Mae and Freddie Mac were back in the headlines too. According to an article in a journal, there is no alternative but to nationalize them.

Other factors are also indicating that the economic problems in the US are by no means over yet. Hopes that the housing market could have bottomed out were crushed by the building permits and housing starts figures. The significant decline in August indicates that the downward trend is still underway, at least in the new homes sector. Furthermore, it is striking that the various Fed representatives, whose opinions as to the necessity of tightening monetary policy differ considerably, agree unanimously that the US economy will not recover for quite some time.

Next week, the focus will probably be on the European side again. The development of consumer prices in August, national climate indicators such as ifo and GfK, and the results of the EU Commission’s survey are all on the agenda.
Detailed German GDP data for the second quarter, German labour market figures for August and eurozone money supply and credit growth figures are also due to be released. These data will have a key impact on market participants’ expectations of the outcome of the ECB Council meeting on 4 September.

As classical leading indicators, results of surveys are of course difficult to predict. We are expecting the ifo business climate to have stabilized – not because we have become more optimistic about the economy, but because it had plummeted in July. Accordingly, the assessment of the current situation is likely to be worse. We think it possible, however, that, as in the case of the ZEW, expectations, which are very negative as it is, could have improved very slightly, because of the decrease in prices for oil and other commodities and the depreciation of the euro. Furthermore, the deterioration in the retail trade business climate in July could have been exaggerated due to the holiday period and the hot weather.

The August consumer price data are particularly interesting, as this was when the energy price decline started having an effect. In Germany, we are expecting prices to have fallen by 0.3 percentage points due to fuel and heating oil; the annual inflation rate could thus go down from 3.3 to 3.2%. This would only be a slight decline, but it could mean that inflation has peaked. On the eurozone level (the flash estimate for August will be released on Thursday) we think that the inflation rate will probably have remained unchanged at 4.0% in August, but there is also a chance of improvement.

Based on the new projections, the ECB Council’s September meeting will, to a certain extent, pave the way for the coming quarter. If the ifo and the other sentiment indicators stabilize, some market participants, who are at present banking on interest rate cuts, could become more cautious. The development of inflation described above is more or less in line with general expectations. Market participants might even be slightly disappointed that the substantial fall in oil prices did not push inflation down further.

In the run-up to the ECB Council’s meeting, we are expecting the bond markets in the eurozone to remain on the weak side. We see EUR-USD near the top end of its new trading range, which we put at approximately 1.46 to 1.49.

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Published on  Mon, Aug 25 2008, 06:25 GMT