Sudden rise: inflation rate rises to 3.8 percent

Consumer prices in Germany skyrocketed in July and are approaching the four percent mark. The reason is the VAT effect. A reaction from the central bank is unlikely to be expected.

After the inflation rate was moderate in June, it accelerated significantly in July. As the Federal Statistical Office announced in the afternoon, the price of goods and services rose by 3.8 percent year-on-year this month – the highest value in 13 years. Compared to June alone, German consumer prices rose by 0.9 percent.

There is no end in sight to this development for the time being. On the contrary: “In the coming months the inflation rate will remain high and even increase somewhat,” says Holger Schmieding, chief economist at Berenberg Bank. Bundesbank President Jens Weidmann expects the inflation rate to move towards the end of the year in the direction of five percent.

VAT effect is responsible

According to the Federal Office, the VAT effect is primarily responsible for the high rise in the inflation rate in July: The federal government lowered the rates in the second half of 2020 in order to relieve the economy and consumers in the corona crisis and to stimulate consumption. Now the prices are compared with the lower ones back then, which also drives them up.

Economists also suspect that some service providers, such as restaurateurs, have used the recent Corona easing to raise their prices when demand is high. Gasoline is proving to be another price driver. This has increased dramatically in the last few weeks. In the first half of the year, German consumer prices had already risen more sharply than they had for around ten years, because oil and gasoline in particular had risen sharply.

The ECB is unlikely to react

A reaction from the European Central Bank (ECB) is unlikely to be expected. It is aiming for an inflation rate of two percent, but according to the most recent changes in its monetary policy, it is ready to tolerate upward and downward fluctuations for a longer period of time. The central bankers are also convinced that the current price increase will only be of a temporary nature and that consumer prices will calm down again at the beginning of next year.

This means that an increase in the record-low key interest rates is still not to be expected. These are now to be kept at the current level or an even lower level until it can be seen that inflation has sustained two percent.

According to ECB Director Fabio Panetta, such a scenario is not in sight. Panetta advocates letting the economy run really hot in order to raise the rate of inflation to two percent. It may be necessary to rev up the economy a little, said the member of the six-strong management team of the central bank in an interview published in the morning with the Italian newspaper “Corriere della Sera”. “In the past, impatience has led the ECB to hike rates too early, maintaining undue downward pressure on inflation and slowing growth.”

Panetta does not consider such an approach to be risky. “On the contrary. It’s a way of adding credibility to our efforts to bring inflation up to two percent,” he said. The aim is to fully utilize the available labor force and to generate wage pressure so that inflation is raised to the target level.