What explains the strength of inflation in January? - Capital Economics
European Economics

What explains the strength of inflation in January?

European Economics Update
Written by Jack Allen-Reynolds

January’s surprisingly large increases in inflation in Germany and Spain were due to a range of factors, including a rise in VAT, higher energy and holiday prices, and methodological changes. As a result, inflation is likely to be higher than we had expected this year.

  • January’s surprisingly large increases in inflation in Germany and Spain were due to a range of factors, including a rise in VAT, higher energy and holiday prices, and methodological changes. As a result, inflation is likely to be higher than we had expected this year.
  • Inflation data for Germany and Spain this month caught us and the consensus off guard. Data released yesterday showed that the EU measure (HICP) in Germany increased from -0.7% in December to +1.6% in January (see here, consensus +0.5%), while data published this morning showed that inflation in Spain was also much stronger than expected, rising from -0.6% to +0.6% (consensus -0.6%).
  • So far the German and Spanish statistics agencies have published only limited breakdowns of the January data, but the press releases gave some helpful information. In Spain, the inflation rates for energy and food were singled out as having increased particularly quickly. This might partly reflect the rise in global oil and agricultural prices so far this year. (See Chart 1.) Package holiday inflation in Spain also jumped in January, but these prices had to be estimated for large parts of last year as price data were simply unavailable. That is likely to have been the case in January too. So these data should be taken with a pinch of salt.
  • In Germany, a hike in carbon pricing added to the effect of higher oil prices. The breakdown of the national measure of inflation showed that energy accounted for about a third of the increase in headline inflation. Meanwhile, the increase in VAT in January will also have boosted inflation.
  • It also seems likely that clothing sales which normally take place in January throughout the euro-zone have been delayed or cancelled due to the lockdowns. That would mean that, compared with January 2020, clothing and footwear prices would look particularly high. This effect would reverse in February.
  • Additionally, new weights will be applied to the items in the HICP basket in 2021, which has also pushed inflation up. The HICP weights change every year to reflect shifts in consumers’ spending habits. These changes are typically quite small, but will have been bigger this year because the pandemic has caused such large changes to consumption patterns. As Chart 2 shows, HICP categories with higher inflation rates in Germany tended to see their weights rise, whereas the weights of categories with the lowest inflation rates tended to fall. We think this effect added about 0.2%-points to German HICP inflation in January.
  • Bringing all of this together, euro-zone inflation is likely to be a bit higher than we had previously assumed this year, but it is not yet clear by how much. After all, inflation in Portugal did not pick up anywhere near as quickly as in Germany and Spain, so the latter two countries could be outliers. We will get more information on the drivers of January’s pick-up in inflation as more detailed breakdowns and the euro-zone aggregate are published over the next few weeks, so we will reassess our view in due course.

Chart 1: Oil & Agricultural Prices in Euros (% y/y)

Chart 2: Change in German HICP Category
Weights vs. Inflation Rate in 2020

Sources: Refinitiv, Destatis, Capital Economics


Jack Allen-Reynolds, Senior Europe Economist, jack.allen-reynolds@capitaleconomics.com