Low German Inflation Continues to Hide Underlying Economic Strength

German inflation figures may be low, but stronger than expected growth rates, rising confidence indicators and an ever tighter labor market make the ECB’s monetary policy look too expansionary for the Eurozone’s largest economy. With diverging economies within the Eurozone, German is poised to expand at a rapid rate as the European Central bank waits for Germany’s neighbors to catch up.

The first wage deal for this year suggests the strongest rise in real income for many years and above average increases in labor costs are set to undermine German competitiveness in the medium term. At the same time the risk of a property bubble is also rising.

German Q4 GDP growth was confirmed at 0.7% quarter over quarter, confidence indicators are climbing higher, with especially consumer confidence rising sharply. The labor market is already tight and Thursday’s jobless numbers showed another stronger than expected dip in headline rates. Inflation may be low at the moment, but mainly due to the impact of lower oil prices and from a German perspective, monetary policy clearly is already looking too expansionary even before the ECB starts its bond buying program.

The trend will boost consumption and domestic demand as exceptionally low interest rates are limiting the willingness to save. The German GfK consumer confidence numbers Thursday, showed a sharp rise in income as well as an improvement in the willingness to buy. This ties in with the details of German Q4 GDP numbers, which showed that in this recovery consumption and not exports, is a key driving factor.

For many Germans, urged to build up private pension portfolios property investment is looking increasingly attractive. Apparently safer than stock markets, but with considerably higher returns than bonds. While the price of the average property transaction is rising, the share of income private homeowner’s use for interest rates and repayments has fallen over the past years.

The current low interest environment won’t last forever and we have seen in countries such as Spain, Ireland and Portugal what happens when investors are unprepared for a rise in financing costs. The ECB argues that safeguarding against the risks of a property bubble are up to national central banks and governments. Germany has been promising measures to limit the trend and the Bundesbank is keeping a close eye on developments, but with the ECB preparing for even more easing measures, this is an area of risk that should not be overlooked, especially considering the devastating effects of the property crashes elsewhere. IF Germany should face the same problems, who would be there to bail out the largest country in the Eurozone.

With the ECB poised to begin its bond purchase program on Monday and sovereign bond hard to source, prices will continue to move higher which in turn should weaken the European currency. (Source)