At this rate, the Weimar jokes may be out of fashion by the end of 2023.
German inflation decelerated more than expected in December, data out Tuesday showed, but there were caveats aplenty.
As the release noted, a “one-off federal payment to cover monthly gas and heat had a downward effect on prices.” It wasn’t immediately possible to quantify that effect (Tuesday’s data was preliminary), but as ING’s Carsten Brzeski noted, “for the time being, it is lower energy prices and hence base effects, as well as government interventions that are pushing down headline inflation.”
The 12-month inflation rate for household energy and motor fuels was “just” 24.4%. That was the slowest pace since Russian tanks rumbled into Ukraine.
But, again, it’d be foolish to celebrate. Food inflation ran near 21% last month, according to the provisional figures. That was just barely slower than November’s 21.1% pace.
Overall, inflation measured on a YoY, national basis was 8.6% in December, while the HICP measure ran at a 9.6% annual pace. Both were the first single-digit prints since August.
The Bundesbank sees inflation sticking above 7% this year. The annual average rate in 2022 was 7.9%, the government said Tuesday. That was the highest since reunification.
Mild weather in Europe and LNG imports have taken some of the sting out of the incoming data, and also out of the scorpion’s tale in Moscow. European gas prices have now erased the entirety of their war-driven surge.
Suffice to say the worst-case winter scenario for Europe didn’t come to pass — or at least not yet. To say it’s premature to sound the all-clear would be a (very) early candidate for understatement of the year.
“Lower-than-expected energy prices due to the warm winter weather could, if they remain at current levels, push down headline inflation faster than recent forecasts suggest [but] there is still significant pipeline pressure stemming from energy and commodity inflation pass-through,” ING’s Brzeski went on to write, adding that “many households will only face the sharp gas and electricity price increases this month.”
One key question for 2023 is obviously whether Vladimir Putin is out of leverage. He still has his nukes, of course, but he played quite a few of his energy cards last year.
“Russia has already made good on its threats to disrupt gas supplies, with piped flows to Europe currently down over 85% YoY,” RBC’s Helima Croft wrote, in her year-ahead geopolitical outlook.
“The remaining Russian gas flows through Ukraine would seem to be at elevated risk for curtailment, especially given the ongoing aerial bombardment of Ukraine’s energy infrastructure,” Croft added, before noting that “with storage levels in Europe remaining relatively robust amid mild weather conditions, the real challenge for the continent on the gas side could come towards the tail-end of 2023 with no additional Russian volumes likely forthcoming.”
As for European monetary policy, the story remains the same: Inflation outcomes in Europe depend largely on the trajectory of energy prices and, more broadly, the war. Recessions across the region are virtually guaranteed, so demand destruction is coming one way or another, and that’s on top of price caps and whatever rationing (voluntary or otherwise) governments manage to foist on the public.
The ECB turned aggressively hawkish at its December meeting, but I continue to believe that to the extent more rate hikes can help bring down European inflation, their contribution is incremental, and perhaps merely incidental.
Christine Lagarde was adamant last month that market participants should expect a series of additional 50bps rate hikes. Should energy prices remain subdued, traders will fade that notion. I imagine the ECB would be (more than) happy to fade it too if fortune decides to smile on Europe in 2023 as recompense for 2022.
That energy prices (and inflation more generally) depend on the war is a point that’s made with regularity, both here and elsewhere.
What do we expect to happen to energy prices should the war end tomorrow? Do we expect Russia to offer gas to Europe again? Do we expect Europe to take it if they do?
Oil would seemingly be unaffected as Russian volumes are essentially unchanged vs prewar and EU/US sanctions (including the price cap) have done everything they can to keep oil flowing.
What else is there, coal?
On the flip side, an end to the war would seem to indicate a vast effort to rebuild Ukraine. The material and labor required for that would seem to be inflationary…
So inflation in Europe is likely to come down in 2023 thanks in the most part to declining energy prices as the worst-case winter hasn’t turned out to be the case. But Lagarde is erring on the hawkish side, likely so she can take some credit on taking down the inflation dragon on the way to reclaiming the lost creditability. A steadfastly hawkish ECB would also likely support the Euro against a weakening USD on a less hawkish Fed, which is dialing down hikes. Seen in that light I can see why Lagarde was and will be as adamant as she can be on additional ECB hikes, regardless of whether she can actually deliver on those 50bps increments. She wants to take back the lost creditability as well as the losses the Euro suffered against the greenback last year.