Eurozone Economic Sentiment Posts Six-Year High as German Inflation Advances

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Germany drove the improvement in Eurozone’s economic confidence in January 2017, which might further complicate Berlin’s already¬-tense relations with the nations of Southern Europe, mainly due to their different economic outlook and view of monetary policies.

Kristian Rouz – Economic confidence in the common currency area hit its highest point since early 2011 in January, a report from the European Commission said on Monday, despite concerns regarding the Italian banking sector and Greek debt.

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The European Central Bank (ECB) therefore finds itself under more pressure to normalize monetary policies in the form of possible rate hikes and a withdrawal of stimulus; German inflation accelerated in January.

The European Commission said their measure of business and consumer confidence hit a six-year high at 108.2 compared to 107.8 in December 2016, surpassing the previous estimates that this metric would remain static. The stagnant Eurozone economy showed signs of improvement, driven by Germany's powerhouse economy, where inflation seems to have taken off in the most prominent industrial regions.

Regional inflation data, published early on Monday in Germany, indicated that prices have advanced 2.1 percent in North Rhine-Westfalen, 2.3pc in Saxony, and 2.4pc in Hesse, where the ECB is headquartered in the city of Frankfurt-am-Main. Additionally, inflation in Brandenburg, home to the nation’s capital, Berlin, and Bavaria, added 1.7pc.

These numbers fall in line with the ECB’s inflation target of 2pc, indicating that, out of the entire Eurozone, Germany is not only the biggest, most sustainable and successful economy, but is also the healthiest. Subsequently, these figures add to the frustration of the Germans as their nation is confined to the limitations imposed by the economic union with less successful national economies, particularly those of the Southern Europe.

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Wolfgang Schaeuble, the German Finance Minister, said these numbers might stir more “political problems” as Germany is increasingly insistent that the ECB should be more decisive in normalizing the Eurozone's monetary conditions.

However, Italy and Greece, mired in banking sector deficiencies and excessive public debt woes, respectively, would not weather higher central bank borrowing costs.

“It’s a completely overblown discussion,” Carsten Brzeski of Frankfurt-based ING-DiBa AG said. “As long as you have core inflation of around 1 percent in Germany, there really isn’t any reason to worry. You also have to ask yourself ‘can the ECB even react?”’

Meanwhile, as economic sentiment has improved in January across the Eurozone, calls for the ECB to wrap up its stimulus package are becoming more prominent outside of Germany as well. ECB President Mario Draghi, however, said it is still premature to discuss any potential stimulus withdrawal as core inflation is still weak at below 1pc, and the economic outlook is marred, including because of the perceived trade disruptions on the British front.

“Short-term sentiment indicators are quite positive but there’s a lot of risk and a high probability that they won’t be matched by growth picking up,” Aline Schuiling of Amsterdam-based ABN Amro Bank NV said. “It’s a bit early to be overly optimistic and confident.”

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In Germany, however, not everything is perfectly well. Specifically, German business sentiment declined slightly at the start of the year, and the manufacturing and services sectors retreated to their four-month lows. Overall inflation in Germany, nonetheless, has picked up to 2pc in January, giving Berlin just enough evidence to push through with the tighter borrowing costs agenda.

Eurozone economic growth has likely picked up to 0.4pc year-on-year in the fourth quarter due to the acceleration in Germany and Spain, meaning that even though German inflation is a clear sign to the ECB, Draghi might not be rushing to remove the stimulus, thus putting economic growth under downward pressure.

On the ECB Executive Board, Sabine Lautenschlaeger reiterated that “all preconditions for a stable rise in inflation exist,” and that monetary policy normalization is to be hotly debated. Jens Weidmann, President of the German Bundesbank, warned that extended stimulus in the form of bond buyouts and low borrowing costs is stirring unnecessary risks.

“You have periphery states with very low inflation because capacity isn’t fully utilized there, and Germany, where a higher capacity utilization results in a stronger upward trend of prices,” Stefan Kipar of Munich-based Bayerische Landesbank said. “It’s a mathematical equation – even when the ECB reaches its goal of inflation just below 2 percent on average, some countries will have lower rates while others will overshoot.”

Such a discrepancy between the more disciplined North and the South, which is mired in debt and economic inefficacy, is a challenge to broader Eurozone political stability, and has been debated since the common currency area encountered its first economic difficulties in the mid-2000s. A solution has not yet been found, as the nations with such drastically different economic models as Germany and Portugal, for example, would require different central bank approach to monetary policy, which, within the single currency area, is hardly possible.

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