Why the ECB is Comfortable with High Inflation

Inflation has steadily crept up in Germany over the past few months from 1.0 percent in January to 3.8 percent in July. Moreover, the end is not yet in sight and inflation could reach five percent by late fall. For the first time in three years, inflation exceeded the ECB’s two-percent target at 2.2 percent in July. The new symmetrical inflation target gives the ECB somewhat more maneuvering room to counteract target deviations than before.

The current inflation excess should certainly qualify as ‘slight.’ But will it stay that way? Probably not - given the high likelihood of Euroland inflation temporarily reaching about three percent this fall. It therefore comes as no surprise that Germany in particular is going to keep a close eye on inflation, or at least a closer eye than most other countries.Is the ECB behind the eight ball, meaning that its monetary policy is lagging behind real economic developments?

However – and we tend to give this point not its due respect – the ECB’s mandate is to monitor price development in ALL of Euroland. Inflation in other European countries is quite different from Germany. The harmonized inflation rates (differing slightly in terms of national price indices owing to minor varia-tions and weightings in their baskets of goods and services) in almost all of our neighbor countries are lower than in Germany, in some cases they are substantially lower. The higher inflation in the past few months was primarily the result of a strong rise in energy prices. Assuming that oil prices remain at the currently high level, Euroland inflation will drop back to below two percent already in the beginning of next year. As such, we are comfortable with the ECB keeping the monetary reins slack for now.