German inflation jumps to its highest level in years

Economists expect consumer prices in Europe's largest economy to continue to rise in the coming months, with some projecting inflation rates could reach 5 per cent.

Rising inflation has meant the money in Germans' pocket buys less. Photo: dpa/picture alliance

Inflation in Germany continued to rise in August, with the nation's Federal Statistical Office announcing on Monday that prices rose 3.9 per cent year-on-year, according to preliminary calculations. It's the highest inflation the country has recorded in over a quarter of a century. The last time annual inflation was higher than this was in December 1993, when it was 4.3 per cent.

Consumer prices in Europe's largest economy have been increasing for months, fueled by rising energy and food prices as well as the withdrawal of a temporary reduction in value-added tax (VAT), which was aimed at mitigating the economic effects of the COVID-19 pandemic last year by boosting domestic consumption.

The reduction in VAT was in effect from July 1 to December 31, 2020. Economists expect consumer prices to continue to rise in the coming months, with some projecting inflation rates as high as 5%. But they view it as a temporary phenomenon.

"The current increase is likely to remain temporary," Christine Volk, chief economist at public lender KfW, told the AFP news agency.

A return to inflation under the European Central Bank's (ECB) 2 per cent target was likely, she said, but warned that shortages of key components such as computer chips could have an "impact on consumers' wallets, as companies are likely to pass on the higher costs at least partially."

Is it just going to be temporary?

Higher inflation, meaning a rise in prices across an economy, weakens the purchasing power of consumers. In other words, the money in your pocket buys less. In the case of hyperinflation, prices rise by 50 per cent or more per month. In the 1920s, extreme hyperinflation in Germany devastated the economy and fueled political instability, which preceded Nazi rule.

But central bankers say the current rise in prices is a temporary fallout of the economic disruptions caused by the coronavirus global health emergency. Supply chains have been disrupted by demand first collapsing and then coming back quickly, making prices volatile.

They argue that factors pushing up prices would disappear once the global economy normalizes, pandemic-hit businesses return to full capacity and supply chain issues are resolved. But others are skeptical. They warn that high inflation could last longer than central bankers currently think.