29 April 2003

EZA 525 - Germany - Economy

German goods inflation to move negative this year, keeping downward pressure on ECB rates
The resumption of the downtrend in German headline inflation in Apr03 to 1.1%y/y, coupled with forward-looking indicators point to a further fall in coming months. This implies continuing downward pressure on euro bond yields. Euro strength is holding down PPI and import prices, while goods prices — the biggest CPI component — are likely to fall into negative territory, and service price inflation should decelerate due to lower wage growth and unwinding of last year’s euro change-over related price hikes. Hence the current inflation gap between Germany and the euro area aggregate of 1.5pts is likely to persist, implying higher real interest rates in Germany than elsewhere. The relative tightness of monetary policy for Germany will, we think, prolong the weakness in the real economy and the financial sector (EZA rpts 521/03Apr18 & 524/03Apr29). Germany still needs lower interest rates and more market liberalisation at European Union and national level to reduce the risk of spreading deflation and foster competition.

SummaryAsset conclusions: Continuing disinflation implies bond yeilds to stay low in medium term; deflation-prone equities sectors should be avoided.

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© Graham Bishop