CPI (Consumer Price Index):

This is a collection of products and services (such as food, housing, energy, automobiles) and consists of what an average household purchases. It gives an average price change over time of this basket. It is the primary measure of the cost of living and inflation.

MoM (Month-over-Month): It is a particular release of the percentage change of the CPI over one month to the last month.

 An example: When CPI stood at 100.0 in January and 100.3 in February, the change in the MoM is +0.3.

This is published by Destatis (Federal Statistical Office of Germany) which is typically issued in the later part of the month after the month of reference (e.g. the data of February is released in the mid-March).

Why So Intensively Does It Monitor This Economic Indicator?

Germany has the biggest economy in Eurozone commonly known as the economic engine of Europe. Thus, its financial statistics impact hugely.

Price Stability Key Gauge of the European Central Bank (ECB): the primary mandate of the ECB is the price stability which is expressed as inflation of less than but near to 2% in the middle term. Inflation figures of Germany form a very essential input in the monetary policy decisions made by the ECB. High German CPI reading may encourage the ECB to increase interest rate whereas low reading can reinforce the more dovish (accommodative) position.

Leading Indicator of Eurozone Inflation:

German CPI is considered a bellwether of the overall Harmonised Index of Consumer Prices (HICP) in the Eurozone which follows shortly. The German data is used by the traders and analysts to narrow their expectations of the Euro zone figure.

Impact on Financial Markets:

   -Euro (EUR): An increase in CPI (MoM) which is above the expected value is a positive indicator to the Euro. It is an indicator of the growing inflation rates, which increases the likelihood of a tightening of         the monetary policy by ECB (increasing interest rates), which brings foreign capital to those Euro-denominated assets.

   -Bonds: With an increase in inflation, bonds have a declining fixed return. The result of a high CPI is normally an increase in German government bonds yields (particularly the Bund yield) and a decline in          the price of bonds.

   -Stocks: The impact is mixed. High inflation may damage profits of the companies (costs of inputs are increased) and cause increase in interest rates, which decrease present value of future earnings.              Nevertheless, such sectors as commodities or energy could be a plus.

The Important Information to Be Found in the Release.

The number MoM in the headline is not the only thing to notice when the report is released. Dig deeper:

The most important difference is between Headline and Core CPI.

-      Headline CPI: This entails all the items in the basket including the volatile food and energy prices.

-      Core CPI (MoM): It is excluding energy and food. It is believed to be a superior indicator of underlying, trend inflation since it eliminates short-term inflation in prices (e.g. a spike in oil prices as a result of             a geopolitical event).

-       Analysis: It may be temporary to have a high headline CPI that was solely powered by energy. But when the Core CPI is also increasing steadily then it indicates that inflationary pressures are becoming broad-based and more permanent of which the ECB is more concerned about.

Drivers of the Change: The Destatis report will always separate which elements had the greatest contribution to the change in the month.

-           Energy Prices: Generally the largest source of monthly volatility.

-           Food Prices: This is another usual cause of fluctuation.

-           Services Inflation: This is a closely monitored inflation because it is usually associated with the growth in domestic wages and has been found to be stickier (harder to decline).

  Revisions: Be aware of any revisions of the data of past months. A major update can even be as commercial as the new information.

Practical Case: The Interpretation of a Release.

Suppose that the report is issued in February:

            Headline CPI (MoM): +0.7% (Forecast: +0.5%)

            Core CPI (MoM): +0.4% (Forecast: +0.3%)

Interpretation:

This is a hawkish shock (an increase in inflation). The figure in the headline was not only beating the expectations but the Core reading was also hot. This implies that it is not only volatile energy prices that are causing inflation but it is becoming entrenched in the economy (e.g. increased prices of services).

Effect on the market:

            The Euro (EUR/USD, EUR/GBP) would most likely appreciate.

            The German Bund yields would be projected to increase.

            The expectation of an increase in the ECB interest rates in the market would rise.

Drawbacks and criticisms:

            One-Size-Fits-All Basket: The basket might not be a precise indicator of the expenditure of all households (e.g. the basket of a retiree is not the same as the basket of a student).

            Quality Adjustments: The CPI attempts to include the quality improvement in products that are subjective.

            Lagging Indicator: It is a report of what is already done rather than the future price pressures.

Summary

German CPI (MoM) is a high-frequency, high impact, economic statistic which offers a priceless early picture of inflationary pressures within the largest economy of the Euro zone. The impact it has on the monetary policy of the ECB and, by extension, the value of the Euro and European financial markets, particularly its currency traders, investors and policymakers around the globe makes the data an indispensable data point. It should always be analyzed together with the figure of Core CPI and the detailed breakdown presented by Destatis.

Powered by Froala Editor