OpinionPrice levels

Inflation has yet to return to normalcy

The notable decline in inflation in Germany during September is a positive development. Yet, it's premature to assume everything is back to normal. The ECB needs to stay alert. The upcoming interest rate meeting in December will be closely watched.

Inflation has yet to return to normalcy

The substantial decrease in inflation in Germany in September is indeed noteworthy. In the harmonized EU calculation, it dropped by more than two full percentage points, from 6.4% to 4.3%. A similar trend is expected for the entire Eurozone, with a forecasted decrease from 5.2% to 4.5%, as indicated by the preliminary estimate released on Friday. Is there peace on the inflation front at last? Far from it! While the development is positive, it's premature to declare an all-clear signal.

To put this briefly into perspective: even if it's "only" 4.5%, the inflation rate in the Eurozone, apart from the current inflation spike, remains exceptionally high. Before the surge in 2021 and 2022, that was worsened by the delayed actions of the European Central Bank (ECB), the highest value in over two decades of Euro history was 4.1%, which was recorded in July 2008. This fact alone should suffice to understand that normalcy is still far from reality, even though the inflation rate has more than halved from October 2022's 10.6%.

Rising oil prices complicating matters

More importantly, while the situation has improved and upstream price trends give hope for a downward trend in inflation in the coming months, the current sharp decline is primarily due to base effects – such as the expiration of the 9-euro ticket and the fuel discount in August 2022. The recent sharp increase in oil prices, along with persistent service sector inflation and substantial wage growth, could make the decline in inflation even slower than expected.

The rising oil prices, in particular, complicate matters for central banks, especially for the ECB. It exacerbates the dilemma of persistently high inflation and increasing recession risks, which even turns into a trilemma when considering the significant uncertainty regarding the exact impact of ECB tightening in times of structural economic changes. Following the substantial underestimation of inflation in 2021 and 2022, the ECB cannot ignore a rise in oil prices as easily as it did in the past.

ECB must remain extremely vigilant

The decline in inflation is undoubtedly good news for the ECB. However, the central bank must remain extremely vigilant, especially concerning inflation expectations. With the recent interest rate hike and the new inflation data, the ECB now has the time to observe and analyze the situation. The October interest rate meeting is likely to be a transitional phase. The real excitement will return in December.