Surging German Inflation Points to a Weaker GBP/EUR Exchange Rate in 2017

German inflation is on the rise, and we believe this signals a stronger Euro ahead.

Destatis reports that Germany’s Consumer Price Index measure of inflation rose at 2.2% in February 2017, putting the UK’s 1.8% reading in the shade.

Such a high rate of inflation was last measured in Germany in August 2012.

This has notable implications for the outlook of the Euro exchange rate complex we believe could ultimately soon have to start strengthening as monetary policy in the Eurozone shifts to the new reality.

The Pound currently buys 1.1650 on the inter-bank market while we believe retail banks to be offering rates in the vicinity of 1.1379-1.14 on international payments. Independent currency specialists are seen quoting towards 1.1550 for the same service.

The European Central Bank (ECB) continues to run an ultra-loose monetary policy, supplying buckets of Euro’s into the economy via its Asset Purchase programme while at the same time keeping interest rates at record-lows.

All this to support the weaker economies in the Eurozone - such as Greece and Italy.

The side-effect of this supply of money is a weaker Euro which languishes near multi-year lows against the US Dollar and other global currencies.

"With ECB policy rates firmly anchored - two year EUR swap rates have remain stuck at -0.30/35 over the last four months - EUR real interest rates are falling and should be negative for the EUR," says Chris Turner, Global Head of Strategy at ING in London.

Of course, the weak Euro proves beneficial to the German economy by stimulating global demand for their industrial output, something that has received attention of late from the new US administration after trade chief Peter Navarro recently suggested the Euro is too low for Germany and is bestowing them an unfair advantage.

However the negative side-effect of such loose monetary policy are higher prices, particularly in countries such as Germany that are running near full-employment, and this could soon outweigh the benefit of stronger exports

It is arguable that Germany needs interest rate rises to ensure economic stability as rising prices are decimating German savings which are already struggling under the meagre interest rates on offer, which are of course a consequence of ECB policy.

As noted by Michael Nienaber at Reuters, inflation is a red flag for many Germans whose families suffered from depreciation of money and mass unemployment in the 1920s.

"It's high time for the ECB to move away from its ultra-loose monetary policy," Bavarian Finance Minister Markus Soeder told Frankfurter Allgemeine Zeitung (FAZ) newspaper.

So we have a scenario where the influential Germans are likely to get increasingly vocal in their displeasure of ECB policy which could in turn shift the ECB into pulling back on their Asset Purchase programme and maybe even consider raising interest rates.

Analysts are in agreement - the one ticket to a stronger Euro in 2017 will be the announcement by the ECB that they are to withdraw their monetary support to the Eurozone in a move colloquially referred to as ‘tapering’.

And Germany could be at the forefront of calls for the taper to start sooner rather than later, in which case those watching the Pound to Euro exchange rate should be prepared for weakness.