Seldom has there been so much and such great uncertainty at the beginning of a new year. A particularly important question here is what economic policy the future US president Donald Trump will really embark on in the end. Additional uncertainty is created by the oil price and the outcome of many important elections in Europe.
A few days ago OPEC agreed to cut the crude oil output for the first time in almost 10 years. OPEC’s main goal is to deplete excessively high global oil stockpiles. These have been having a negative impact on the crude oil price for some time now. The announcement alone had an immediate effect: the prospect of a reduced oil supply caused crude oil prices, which had fallen steeply in the previous weeks, to rise briskly again. Brent and WTI crude climbed more than 10 per cent in the first few days of December to peak at over USD 50 per barrel.
Changes in crude oil prices in the world market usually work through very rapidly into prices at the gas stations and heating oil dealers in Germany. So does the recent oil price buoyancy mean that we have to expect higher inflation rates again in the coming year?
Generally speaking, we believe there is very little danger of inflation for Germany and also for the economy in the entire euro area. Nor will the latest rise in oil prices do anything to change this as in the euro area countries we still have a high level of unemployment, although this is admittedly falling slowly. This runs counter to any major price buoyancy.
Given the robust development in the German employment market, wage growth could admittedly accelerate somewhat faster here than in the other big euro area member states. But overall no major wage pressure is to be expected not least because the labour force has increased significantly as a result of recent immigration. Especially in the lower wage segments this is preventing wages rising more steeply.
For the euro area states as a whole we assume the inflation rate, as measured by the Harmonised Index of Consumer Prices (HICP), will rise from 0.2 per cent this year to +1.4 per cent next year. In the same period German consumer price inflation will probably also only increase from +0.3 per cent in 2016 to +1.4 per cent in 2017.
Energy prices play a highly important role in the very moderate rise in inflation that is expected in 2017 as the massive correction of the crude oil price since mid-2014, when it still stood at over USD 110, is now gradually disappearing from the statistics. The base effect that had spilled over from the oil price into the energy prices in the consumer goods basket is now running out. And even though the oil price has recently risen to over USD 50 again, we do not expect energy prices will show any further major buoyancy.
Several – in some cases opposing – effects will impact the oil price next year: on the one hand, taken in isolation the recent OPEC resolution could lend the oil price greater buoyancy. On the other hand, other important oil producing countries – particularly the USA – have enough capacity to increase output if oil prices rise significantly. Such possibilities of expanding the supply put a ceiling on the potential for price increases. In our view, this means that the price of Brent crude, which is the relevant blend for the European economies, will rise only slightly from its current level of around USD 54 to an average of around USD 58 by the fourth quarter of 2017.
However, if the OPEC effect were to evaporate again rapidly, the oil price could also move in the other direction again. At the end of 2017 it could then again be far lower at around USD 40. But even in this case we would still not expect the inflation rate to fall steeply again. It would then probably drop again temporarily below the one-per-cent mark in Germany as well as in the euro area in the second half of 2017, but would certainly not provide any grounds for renascent fears of deflation.
What other external factors could exert a stronger influence on the inflation rate in the coming year? If U.S. President-designate Donald Trump really implements some of his election campaign promises and hampers international trade with protectionist measures, then goods imported from the USA would probably become more expensive. Even though the negotiations for the free trade treaty that had been planned between the EU and the USA will probably not be taken any further under Trump, we believe it is highly unlikely that other existing trade agreements between the major economic areas on either side of the Atlantic will be terminated as this would cause abrupt trade disruptions.
Other election campaign ideas do indeed have the potential to accelerate the inflation rate, at least in the USA. Trump’s planned economic stimulus measures could have a positive impact on economic growth and inflation in 2017. So far the very robust employment market performance in the United States has created hardly any major wage pressure. However, the additional economic stimulus could lead – via a further increase in employment – to bottlenecks in some sectors of the jobs market and thus to stronger wage growth in the USA. Overall, the inflation rate in the USA will probably increase far more in the coming year than in the European Monetary Union. We expect an increase of 1.3 per cent this year to 2.3 per cent in 2017.
The exchange rate plays a crucial role in transmitting external inflation trends to Europe or Germany. A massive depreciation of the euro against the US dollar could drive domestic inflation higher by way of more expensive imports. But such a significant exchange rate movement would require a fundamental reappraisal of the economic situation. The USA would have to be perceived even more as a safe haven for investments. On the European side, election victories by populist parties in the coming elections in the Netherlands or in France could cause considerable uncertainty among investors. However, in our view these are merely risk scenarios. Our euro/US dollar forecast puts the exchange rate at USD 1.12 per euro by the end of 2017.