German inflation heading for 5%, 'but who cares'?

German inflation rose sharply in July. On the national standard it is now 3,8%, on the harmonized European standard it is 3,1% (was 2,3% and 2,1%). An increase in year-on-year inflation was expected as VAT was temporarily cut in July last year, while it returned to its previous level in January this year. So there is a base effect. But the rise in inflation also slightly exceeded expectations.

In addition to VAT, logistical disruptions and higher raw material prices play a role. In July, prices were 3,6% higher than in January according to the national measure. This ignores the VAT increase and I think it's quite a lot. Still, the numbers are inconclusive about whether the higher inflation is temporary or not. Given the development of prices last year, it is very likely that the German inflation figure will increase further in the coming months. I wouldn't be surprised if the national measure comes in well above 5% later this year, especially in November, and the so-called HICP measure not far below 5%. At the beginning of 2022, the numbers will clearly fall again, but by how much? Financial markets did not react to these numbers this week and that is not likely to change for the foreseeable future.

Eurozone Economic Sentiment sets new record
Eurozone economic sentiment improved further in July, according to the European Commission's index, the sixth monthly rise in a row. The index's level of 119,0 (117,9 in June) was a record high for this series (as far as I can tell, the series goes back to 1985). I found it remarkable that the sub-index for industrial business confidence also rose: 14,6 versus 12,8 in June while the news of supply problems still persists.

These supply problems undoubtedly differ greatly from sector to sector. They may be largest in the automotive sector. And since it is more important in Germany than elsewhere, that may explain why confidence among German entrepreneurs actually fell slightly in July, according to the monthly survey by the Ifo Institute. German entrepreneurs have become less positive, especially with regard to the next six months.

Although Dutch industry is an important supplier to German companies, confidence among Dutch industrial entrepreneurs increased further in July, reaching an all-time high (12,3, versus 11,5 in June). What struck me most in the CBS press release was that confidence increased most strongly in the transport equipment industry, mainly because entrepreneurs were much more positive about the expected activity. Do Dutch entrepreneurs in this sector know anything positive about the supply problems that German entrepreneurs do not yet know?

In the meantime, the Dutch consumer continues to play a big part. Retail turnover in June was 6,0% higher than a year earlier, in volume the increase was 5,3%. Those are high numbers, especially when you consider that retail sales also increased strongly a year ago. Statistics Netherlands explicitly reports that turnover in June this year was no less than 16,8% higher than in June 2019. Turnover in the food sector in particular grew strongly last year. That is now less: in June only (but still) +0,2% compared to June 2020. In non-food, turnover was 8,0% more year-on-year. Growth is still strongest in online at 17,3% year-over-year, with the highest growth being achieved by companies using online and physical sales. Companies that only sell online realized a slightly lower growth: 15,0%.

Mixed picture Q2 Eurozone GDP growth
According to an initial preliminary figure, the German economy grew by 1,5% in the second quarter. That did not go well. Growth of 2% was expected after the contraction of 1,8% in the first quarter, which was revised downwards to -2,1%. The hard data on economic growth in Germany is thus lagging behind the various confidence indices, probably a sign that the supply problems in the industry are taking their toll.

The French economy grew by 0,9% in the second quarter. That was slightly better than expected. In addition, growth in the first quarter was revised slightly upwards: from -0,1% to 0%.

The Italian economy grew twice as fast as expected in the second quarter: 2,7% and, as in France, the first quarter figures were revised slightly upwards in Italy: -0,7% instead of -0,8%.

US economic growth is disappointing
I hate 'I told you so' people, but I can't help but say 'I told you so' this time. Last week, I reported that US economic growth in the second quarter may well fall short of many economists' expectations. Admittedly, that was based on NowGDP numbers from the Atlanta Fed. So basically I have to say: 'they told us so'. GDP growth was initially estimated at 6,5% quarter-on-quarter, a bull's eye for the Atlanta Fed's NowGDP. That of course remains good growth (1,6% calculated in our way). In absolute terms, GDP (in volume) surpassed pre-pandemic levels for the first time (by 0,8%).

Consumer spending grew strongly: 11,8% and American companies continued to increase their investments in production resources and software. However, residential construction activities declined, possibly related to the previously higher mortgage market interest rate. Companies also invested less in buildings. Foreign trade contributed negatively to growth because imports rose more than exports. At the same time, companies used up very heavily on inventories, which also contributed negatively to growth. The fact that foreign trade and stock building both contribute negatively to overall economic growth is unusual and implies that significant positive contributions can be expected in the future.

The last picture is from a series from the 'durable goods orders report'. Monthly figures for shipments of capital goods (excluding defense and aircraft) are an important ingredient in investment figures in the national accounts. Although the year-on-year increase is now declining, the total amount continues to increase. I think it's a very nice illustration of how alert companies have responded to the pandemic and the lockdowns: not by moping, but by investing. The trend continues.

Fed thinks about less bond purchases
At his most recent press conference, Fed Chair Jerome Powell indicated that while the criteria for stopping bond purchases have not yet been met, the point is getting closer. It is likely that the Fed will decide at its policy meeting in September to gradually cut its purchases. Given the uncertainty of exactly how markets will react, and with the trauma of the so-called 'taper tantrum' of 2013 still in memory, the Fed will undoubtedly communicate very cautiously and reduce purchases very gradually. I think the impact on financial markets will be limited. In 2013, capital market rates suddenly rose sharply after then-Fed boss Ben Bernanke casually said the Fed might cut its purchases.

Bad news
Overall, I would say that the economy is developing as expected in most major countries. The recovery continues, albeit in fits and starts. However, nothing is happening to alarm financial markets. That doesn't make it all that exciting at the moment. For a freelancer like me who attracts more readers when a lot of exciting things happen, it is obviously bad news. Well, it's no different. As is often said these days: I will have to 'deal' with it.

Hans de Jong

Han de Jong is a former chief economist at ABN Amro and now a resident economist at BNR Nieuwsradio, among others. His comments can also be found on Crystalcleareconomics.nl

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