It was a huge shock. The 37.2 percent increase in German producer prices, or PPI, for July that the Statistisches Bundesamt announced last week. Not only was this the biggest price increase ever, it was also more than five percentage points higher than the consensus expected.
Moreover, this number came before reports of the 50 percent increase in German electricity prices so far in August. And so the question arises, should we be getting ready for a German inflation, or CPI, of over 10 percent?
PPI = CPI
Although there are widespread calls for double-digit inflation figures in the making, I see few good substantiations. Let me make an attempt.
There is a clear relationship between producer price increases and consumer price inflation. This can also be seen in the graph below. The correlation between PPI and CPI is 90 percent.
Based on a simple regression between the PPI and CPI, on the basis of the 37 percent year-on-year increase in German producer prices, headline inflation in Germany should be 8.1 percent. This is higher than the 7.5 percent reported for July.
Electricity prices
Even though estimated inflation is higher than the reported figure, 8.1 percent is still a long way from the ‹magic› 10 percent. However, prices have already shown some fireworks in August. German electricity prices have risen by 50 percent so far. Whether this will continue is of course open to question - the volatility of energy prices is gigantic - but this is what we have to live with for now.
That 50 percent increase translates into an increase in electricity prices of almost 500 percent (!) compared to a year ago. The graph below shows the year-on-year change in electricity prices against the year-on-year change in producer prices. The correlation between the two is particularly significant at 80 percent. So higher electricity prices are indeed working through product prices to the German inflation rate.
Escape?
Yet this does not (yet) have to mean that a 10 percent inflation rate is imminent. The graph also shows the 500 percent increase in electricity prices compared to July’s PPI at 37.2 percent. That ‘point’ lies almost exactly on the regression line between the two price changes. Based on the historical relationship, the 500 percent increase in electricity prices need not be accompanied by an even greater increase in the PPI.
However, little certainty can be given to this statement. The number of data points for extreme price rises is limited. Large deviations from the regression line are common. For example, producer prices have risen by more than 30 percent before without this requiring a 500 percent increase in electricity prices.
Conclusion
Based on the historical relationship between electricity prices and producer prices, Germany can still escape a 10 percent inflation, which would certainly bring back unpleasant memories for our Eastern neighbours. However, the certainty that this will happen cannot be too great with the extreme results we are seeing now. A PPI rise of 47% would be enough to push inflation above 10%.
Whether we actually see the level at 10 percent - I certainly do not rule it out - is irrelevant. German and Eurozone inflation figures call for strong intervention by the ECB, which is lightyears behind the curve.
So assume we get another 50 basis point increase in September. But after that, the economic landscape will probably start to look bleak. A recession is a done deal. Markets, however, expect the ECB to keep tightening until at least the third quarter of next year. But I find it extremely unlikely that this will happen with a recession in the making. And that in turn has clear implications for the euro, which is already well below parity.
Jeroen Blokland is founder of True Insights, a platform that offers independent research to build diversified multi-asset portfolios. Blokland was most recently head of multi-assets at Robeco. His «chart of the week» appears every Monday on Investment Officer Luxembourg.
This contribution originally appeared on InvestmentOfficer.nl.