Why has German inflation posted a surprise drop to 2% in August?

According to a report by CNBC, the harmonised German consumer price index eased to 2 per cent in August, preliminary data from the country’s statistics office Destatis said Thursday. This was lower than the 2.3 per cent forecast in a Reuters poll of analysts. The poll forecasted that the Consumer Price Index (CPI) would be 2.3 per cent.

This decline in inflation can be attributed to several key factors, such as the reduction of energy costs, weakening core inflation, lower-than-expected Consumer Price Index (CPI), and fading growth momentum.

In July, the harmonised CPI figure was 2.6 per cent on an annual basis. Further, the harmonised CPI dipped by 0.2 per cent on a monthly basis. Inflation readings are harmonised in the euro area and in the European Union to ensure comparability. This is done through the Harmonized Index of Consumer Prices.

What Is the Harmonized Index of Consumer Prices (HICP) and its relevance?

The Harmonized Index of Consumer Prices (HICP) is a measure of inflation in the European Union (EU). It reflects change over time in the prices paid by households for a representative basket of goods and services.

The European Central Bank (ECB) uses the HICP for Eurozone, comprising the 20 European Union states, using the euro common currency to pursue its price stability objective, defined as 2 per cent annualised inflation over the medium term.

How was the core inflation number as per the nation’s statistics office?

Core inflation, which strips out energy and food costs, came in at 2.8 per cent compared with the same period last year, slightly lower than the 2.9 per cent in July. Destatis data showed a 5.1 per cent annual drop in energy costs in August.

Several major German states had reported easing inflation earlier in the day Thursday. The data came a day before euro area inflation figures. They are due to be released, which investors will be closely watching for clues about the outlook for forthcoming interest rate cuts from the European Central Bank.

Questions about a potential September rate trim have been swirling after the central bank held rates steady in July. It had reduced interest rates in June.

“If confirmed by tomorrow’s eurozone inflation data, today’s German data should make the decision to cut interest rates at the September meeting a bit easier for the ECB,” Carsten Brzeski, global head of macro for ING Research, said in a note Thursday.

“Fading inflationary pressure combined with fading growth momentum offers an almost perfect macro backdrop for another rate cut.”

However, forward-looking inflation indicators, including wage growth and selling price expectations, suggest caution is still needed, Brzeski noted.