German inflation rises to 3.8% in blow to rate-cut hopes

German inflation accelerated to its fastest rate for three months in December, casting doubt over investors’ hopes that the European Central Bank will start cutting interest rates as early as March.

Inflation in Europe’s largest economy rose at an annual rate of 3.8 per cent in December, up from 2.3 per cent a month earlier, according to the harmonised index of consumer prices released by the federal statistical agency on Thursday.

The reduction of government subsidies on gas, electricity and food that began last year has triggered a re-acceleration of annual inflation in much of Europe.

German energy prices rose 4.1 per cent in the year to December, a reversal from a 4.5 per cent annual decline a month earlier.

Marco Wagner, an economist at German lender Commerzbank, warned German inflation could accelerate further in January due to tax increases and reduced subsidies, predicting it would “ultimately stabilise at 3 per cent” over the course of this year.

French figures released earlier on Thursday also showed inflation rising to 4.1 per cent in the year to December, up from 3.9 per cent in November, reflecting an uptick in price growth for energy and services.

Consumer price growth in the eurozone had been slowing for six months, bringing it close to the ECB’s 2 per cent target. Bond and equity markets rallied in the final weeks of 2023 as investors bet borrowing costs would start to fall in the spring.

But figures for the overall eurozone, due on Friday, are expected to show inflation rose from 2.4 per cent in November to 3 per cent in December, ending six months of consecutive falls.

Carsten Brzeski, global head of macro at Dutch bank ING, said both December’s rise in German inflation and the prospect of additional price pressures from tax changes in January “strengthen the ECB’s point that there will not be any rate cuts for at least the next five months, so June at the earliest”.

The euro held on to gains and eurozone government debt prices stayed lower after the German figures were published. The currency was 0.3 per cent higher against the US dollar at $1.0950, having climbed earlier on Thursday.

The German 10-year bond yield, which moves inversely to prices, was up 0.09 percentage points at 2.12 per cent.

The pick-up in inflationary pressure reflects a comparison with a year earlier when Berlin paid the gas bills of most households and Paris heavily subsidised electricity costs, which drove down the cost of utility bills temporarily. 

Prices also look set to be pushed up further in January after the German government was forced to scrap several other subsidies and increase taxes to help fill a €60bn hole in its budget plans left by a constitutional court ruling against its use of off-balance sheet funds.

One area where prices could rise in response to lower government subsidies is eating out, after Berlin raised the VAT rate on restaurant meals from a temporarily reduced level of 7 per cent back up to 19 per cent at the start of this year. The government also raised the carbon price, cut subsidies for agricultural diesel and increased taxes on domestic flights.

The ECB raised its benchmark deposit rate sharply over the past two years from less than zero to a record high of 4 per cent in response to the biggest surge in prices for a generation.

Swap markets are pricing in about 1.6 percentage points of rate cuts by the ECB this year, with a 60 per cent chance of cuts starting in March.

Some economists pointed to the continued decline in core inflation — which excludes more volatile energy and food prices to give a better picture of underlying price pressures — as a sign that disinflation was still on track to happen quicker than the ECB forecast.

“Today’s report overall solidified the disinflationary trends we have seen in recent months and continue to suggest downside risks to the central bank’s assumptions,” said Oliver Rakau, an economist at consultants Oxford Economics.

The ECB last month pushed back against speculation about imminent rate cuts, forecasting inflation in the bloc would rise from an average of 2.8 per cent in the fourth quarter of last year to 2.9 per cent in the first quarter of this year.

Isabel Schnabel, an ECB executive board member, said last month that inflation might “pick up again temporarily” and would then “gradually” drop to the ECB’s 2 per cent target by 2025, adding: “We still have some way to go.”

Almost 60 per cent of respondents in a Financial Times survey of economists last month predicted eurozone inflation would slow to the 2 per cent threshold in 2024, although some said it was likely to speed back up again from there.