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Bad Omen: More German Inflation Will Lead To Higher Borrowing Costs

Europe’s largest economy continues to have economic problems.

German inflation hit 8.5% in July, which was not only higher than the 8.1% analysts expected but will likely mean the European Central Bank will raise borrowing costs in September, a recent report states.

“This will support what we assume is the majority view on the ECB that another rate hike of at least 50bp [half of one percent] is needed in September,” states the research note from London-based Capital Economics.

The problem for Germany and Europe as a whole is that inflation shows no sign of abating anytime soon. “Food inflation rose from 12.7% to 14.8%,” the report states.

And energy prices look likely to shoot up further later this year. The Kremlin has been reducing its delivery of natural gas to Europe lately and based on past behavior will likely continue to do so. That matters a lot because Europe in general and Germany in particular rely heavily on Russian gas to produce electricity, an essential resource for industry and consumers alike.

Such shortages of energy could become a problem the Capital report states as follows:

  • “Looking ahead, the surge in natural gas prices may push energy inflation up again in the coming months, depending on how much the government intervenes to cushion households from the costs.”

Natural gas recently cost nearly $200 a megawatt-hour, up from around $40 a year ago. It peaked at $228 in March, according to data from Trading Economics.

Those hefty prices will quickly eat into corproate profits and household budgets unless the government continues its subsidies. However, that seems unlikely to be sustainable as the economy slows and tax revenues fall.

In normal times we might say Germany is caught btween a rock and a hard palce. But perhaps given the influence of Russia on energy prices it might be better to say “a rock and a hard man.”

Put another way, there doesn’t look like an easy route for Germany any time soon.