In what may be both good and bad news for the ECB, German inflation jumped more than expected in December, hitting the highest level in more than three years, according to preliminary data. German consumer prices, harmonized with other European countries (HICP), rose by 1.7% on the year, more than double the November increase of 0.7%, the German Federal Statistics Office said.
This was the highest annual inflation rate since July 2013 and stronger than the consensus forecast of 1.5%; it was just shy of the ECB's inflation target of 2.0%
On a non-harmonized basis, German annual inflation picked up to 1.7 percent after 0.8 percent in November; prices rose 0.7% on the month, also higher than the 0.6% expected by consensus.
Rising energy prices and higher food costs were the strongest drivers behind the overall increase, a breakdown of the non-harmonized data showed. The surge in energy prices will only lead to more inflationary pressure now that the lowest prices of 2016 have been "anniversaried."
"These are really strong inflation figures," DZ Bank economist Michael Holstein said, adding that negative base effects of past oil price drops were now fading out. Therefore, German inflation is likely to reach the ECB's target of nearly 2 percent in the coming months, he said.
The data means that the wider euro zone figure, due on Wednesday, will probably come in stronger than expected as well.
A strong recovery in German inflation would give conservatives like Bundesbank's President and ECB rate-setter Jens Weidmann more scope to argue for winding down the ECB's bond-buying program more quickly, Reuters notes. For Mario Draghi it will be good news in the he can claim victory over deflation; on the other hand it will mean an even faster arrival of more tapering and potentially rate hikes, a process which would likely lead to the next deflationary slide following a spike in bond yields which price out ECB bond market intervention.
Still, price pressures elsewhere in the euro zone remain more muted than in Germany, she added, pointing to French annual HICP inflation only creeping up to 0.8 percent in December after 0.7 percent in November. "Accordingly... we doubt that this will lead the ECB to reconsider its policy support," McKeown said.
Meanwhile, while rising prices may be good news for the ECB from a pan-euro zone perspective, they do not necessarily bode well for the German economy. It has been relying on private consumption, a booming construction sector and government spending for growth.
"Indeed, a temporary energy-related rise in inflation this year will dent real incomes growth, which is a key reason why we expect the economic recovery to slow," McKeown said.
The German government expects the economy to have grown by 1.8 percent in 2016 and predicts growth to slow to 1.4 percent this year, mainly due to fewer workdays and weaker exports. Still, economists expect Germany's labor market to remain robust in 2017.