German Inflation Ticks Up: Implications for EMU and ECB

German consumer prices rose more than expected in June.  This was immediately reflected in the recovery of the euro from the session lows toward the highs, albeit within the narrow quarter cent range.  

The preliminary EU harmonized measure rose 0.4%, twice what consensus expected.  That helped lift the year-over-year rate to 1.0% from 0.6%.  

In turn this immediately indicates risk that the preliminary euro area figure, to be reported on Monday, is on the upside.  The consensus had been for a 0.5% rise of the year-over-year rate.  Now it is reasonable to expect a 0.6% or even 0.7%.  Make no mistake about it, this is still too low for most ECB officials, though it is the nearest thing to price stability in the literal sense, but also lends support to claims that the risk of deflation for the euro area as a whole remains low.  

The ECB meets next week.  The German data reinforces the obvious.  After taking fresh initiatives last month, new action by the ECB this month is highly unlikely.  The full impact of its past measures is not clear. After all, the TLTROs will not be available until September. 

Thus far, the negative deposit rate has been implement without much disruption.   It appears that, consistent with the Danish experience, the banks appear to be eating the cost--so far.  To the extent that the ECB's initiatives have bolstered stocks, bonds, and credit, the balance sheet implications for euro area banks more than offsets the negative deposit rate.  

The euro has been confined to about a three-quarters cent range this week:  $1.3575-$1.3650. This has been enough for the 3-month implied euro volatility to slip to new lows and threaten the 5% floor.  The new information this week was really about the US economy.  With doubts raised over the outlook for the US economy, not just by the nearly 3% contraction in Q1 GDP, but by the second consecutive decline (April and May) of real personal consumption expenditures, some like Bloomberg's Richard Yamarone warns that a contraction in Q2 is a probable.  

While possible, it is not really probable.  The composition of growth will change--less consumption.  Yet many economists accepted that the consumption over the past two quarters was not sustainable.  Still, even assuming 4% Q2 growth as some optimistic banks are forecasting, that would put growth in H1 at about 0.5%.  Then assuming growth in H2 is 3% per quarter, it risks a sub-2% growth for the entire year.  

That said, jobs growth has continued apace this year and next week's non-farm payroll report is expected to show another 200k+ increase. It seems that either productivity will suffer or growth will improve.  The latter is obviously more desirable, but some combination seems most likely.