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Draghi's German Problem May Fizzle as ECB Sticks to Its Plan

Inflation rate drops most since 2013 in tandem with energy

Draghi's German Problem May Fizzle as ECB Sticks to Its Plan
Vitor Constancio, vice president of the European Central Bank, Mario Draghi, president of the European Central Bank (ECB), center, and Christine Graeff, director general for communications at the European Central Bank (Photographer: Jasper Juinen/Bloomberg)

(Bloomberg) -- Mario Draghi’s German difficulty may be melting away with the change of seasons.

The European Central Bank president had barely begun the New Year when a winter spike in consumer prices provoked resurgent calls in Europe’s biggest economy for a halt to his institution’s extraordinary stimulus. Now that spring is in the air, the surge has reversed with the biggest drop in Germany’s inflation rate since 2013, implying that one-off effects from energy have been masking underlying weakness -- just as Draghi and his colleagues had predicted.

Draghi's German Problem May Fizzle as ECB Sticks to Its Plan

Spanish data on Thursday chimed with the outcome in Germany, signaling that Friday’s statistics for the euro zone as a whole may go in the same direction. Against that backdrop, policy makers from across the spectrum of opinion on the Governing Council voiced continued support to sticking to the stimulus plan they have -- at least until the end of 2017.

“Hopefully, the wrong calls -- from newspapers, from some politicians or maybe from a certain portion of German economists -- may recede,” said Louis Harreu, an economist at Credit Agricole CIB in Paris. “Now markets may listen to ECB members with a more balanced view: No, the ECB’s target is not reached. No, the ECB’s target is not inflation at 2 percent.”

Not one of the 35 economists surveyed by Bloomberg predicted the German rate of annual price growth would slow as much as it did in March -- to 1.5 percent, down from 2.2 percent in February. While that result partly reflects the timing of the Easter holiday in April this year, it also followed a substantial weakening in the oil price. In Spain, the pace of decline was even greater.

Top economic takeaways on Thursday
  • Inflation in Germany fell to 1.5 percent from 2.2 percent -- the biggest drop in almost 4 years
  • In Spain, price growth slowed for the first time in almost a year, to 2.1 percent from 3 percent in February
  • Economic confidence in the euro area fell, but only just -- to 107.9 from 108 -- and remains near levels not seen since 2011
  • On Friday, inflation in the euro-area is expected to fall to 1.8 percent from 2 percent

On cue, policy makers from around the euro region spoke out in favor of keeping to the current agreed stimulus schedule -- spending another 60 billion euros ($65 billion) a month until the end of the year. Peter Praet, the ECB’s chief economist, declared in Berlin that “the firming of the recovery has not yet translated into a durable strengthening of inflation dynamics.”

Even Dutch Governor Klaas Knot, whose support of stimulus has sometimes been lukewarm, told reporters that the ECB should carry on with its quantitative easing this year -- because “predictability of policy is important” -- before starting to scale back from January.

The German outcome buys respite for the Frankfurt-based ECB, which has had a rough ride of late in the country it calls home. When data at the start of the year showed inflation jumped by a whole percentage point in December, the German tabloid Bild screamed “Raise rates now!” It then jumped another half a percentage point in the following two months, emboldening critics.

It remains to be seen the weakening of inflation may also help the ECB pare down market expectations that a rate hike is coming. After Draghi’s March 9 press conference, the chance of a deposit rate hike by January had risen to over 50 percent, before falling to 35 percent on Friday. Yet, in an interview with De Telegraaf newspaper, Knot said that a first interest-rate increase at the beginning of 2018 “is much closer to my own expectation.”

For the euro zone as a whole, economists predicted before the German data that March inflation will slow to 1.8 percent in Friday’s report, down from 2 percent, according to the median of 52 forecasts. That would be the first weakening in 11 months, in line with the ECB’s view that price growth will peak in the current quarter.

To contact the reporters on this story: Alessandro Speciale in Frankfurt at aspeciale@bloomberg.net, Craig Stirling in London at cstirling1@bloomberg.net.

To contact the editors responsible for this story: Fergal O'Brien at fobrien@bloomberg.net, Zoe Schneeweiss, Brian Swint