The available regional state data suggests that falling monthly prices for food, clothing and transportation – as well as lower heating oil and gasoline prices compared to last year – pushed down headline inflation. Meanwhile, services inflation remained broadly unchanged.
It appears that US President Donald Trump not only made the German economy great again – at least for one quarter, as frontloading effects boosted the economy – but also played an important role in bringing down inflation. The drop in oil prices, as well as the stronger euro exchange rate, have added to disinflationary pressures in Germany, and the entire eurozone.
Unrelated to US trade policies, the softening German labour market is also exerting downward pressure on inflation. Although inflation expectations have recently ticked up, we interpret this as a misreading – attributing inflationary effects to current trade tensions, which are unlikely to materialise as long as Europe refrains from retaliation – rather than as a sign of mounting inflationary concerns.
Looking ahead, at least in the nearer term, German inflation is likely to continue its downward trend, probably dropping below 2% over the coming months. More structurally speaking, two opposing trends will shape the future path of inflation. On the one hand, the cooling of the labour market should take away wage pressures and consequently inflationary pressures; on the other hand, the government’s fiscal stimulus is likely to push up inflationary pressure towards the end of the year and beyond.
As a result, and based on lower energy prices, we now expect German headline inflation to hover around 2% throughout the second half of the year.