Market Analysis

German inflation dropped more sharply than anticipated in August, reaching its lowest point in over three years. This development could facilitate the European Central Bank's decision to reduce interest rates in September.

Preliminary data from the federal statistics office on Thursday indicated that inflation eased to 2.0% in August, marking the lowest level since June 2021, largely due to a decrease in energy prices. Analysts surveyed by Reuters had predicted a reading of 2.3% for August, following a 2.6% year-on-year increase in consumer prices in July, according to data harmonized for comparison across European Union countries.

German Chancellor Olaf Scholz highlighted the positive effects of falling inflation, stating on the social media platform X that people now have more disposable income and that real wages have been rising for five consecutive quarters. "This is good news, and we will continue to monitor the situation," Scholz remarked.

This German inflation report comes just before the release of the euro zone inflation data on Friday. Economists polled by Reuters expect inflation in the euro area to be 2.2% in August, down from 2.6% the previous month.

"The preliminary German inflation figures for August provide the European Central Bank with a strong case for further rate cuts at the September meeting," said Carsten Brzeski, Global Head of Macro at ING. He noted that the report indicates the onset of a broader disinflationary trend that extends beyond energy prices.

Financial markets have now fully priced in an ECB interest rate cut at its upcoming policy meeting in September, with expectations of at least one additional cut later this year.

Energy prices in Germany fell by 5.1% in August compared to the same period last year.

Meanwhile, the German economy contracted by 0.1% in the second quarter of 2024 compared to the previous quarter, heightening concerns about a potential recession. A technical recession is typically defined by two consecutive quarters of negative growth.

"The combination of easing inflationary pressures and slowing economic growth creates an ideal macroeconomic environment for another rate cut," Brzeski commented.

Core inflation, which excludes the more volatile food and energy prices, slightly decreased to 2.8% in August from 2.9% in July.

While this trend supports the likelihood of a rate cut in September, Franziska Palmas, Senior Europe Economist at Capital Economics, cautioned that services inflation remains persistent. She predicted that the ECB would adopt a gradual approach, cutting rates only once per quarter until the deposit rate reaches 2.5%.

Economists foresee a challenging road ahead for inflation.

"Unfortunately, we expect inflation to rise again from here," said Cyrus de la Rubia, Chief Economist at Hamburg Commercial Bank, predicting that the inflation rate could climb back towards 3% within the next six to twelve months.

Paraphrasing text from "Reuters" all rights reserved by the original author.