No Fear of Inflation in Germany as 30-Year Yield Drops Below 3%
No Fear of Inflation in Germany
Hannelore Foerster/Bloomberg
The inflation-fighting tradition pioneered by Germany’s Bundesbank, after the hyperinflation of the 1920s undermined confidence in the Weimar Republic, has left central banks unaccustomed to worrying about declining prices.
The inflation-fighting tradition pioneered by Germany’s Bundesbank, after the hyperinflation of the 1920s undermined confidence in the Weimar Republic, has left central banks unaccustomed to worrying about declining prices. Photographer: Hannelore Foerster/Bloomberg
Angela Merkel’s government is giving Germany something not achieved during the Kaisers, two World Wars or the development of the modern bond market: An interest rate of less than 3 percent on money borrowed for 30 years.
Germany’s 30-year bond yield dropped below that level for a second day after touching 2.96 percent yesterday. The sluggish global recovery from recession means German consumer prices will rise just 0.9 percent this year, according to International Monetary Fund forecasts, less than half the average since 1980. In the U.S., Pacific Investment Management Co. sees a 25 percent chance of a sustained period of falling prices, and the two-year Treasury note yield has also declined to a record low.
“The risk of deflation is much more real than the risk of inflation,” said Christoph Kind, head of asset allocation at Frankfurt-Trust, which manages about $20 billion. “The move in yields is a clear reflection that we are moving toward a deflationary environment. Nobody would be buying if there was a risk of inflation picking up.”
Memories of the hyperinflation that destroyed Germany’s economy in 1923 have set the blueprint for central banking since World War II. Today, bond values suggest that deflation is a much greater threat to economic stability.
Central banks around the world are weighing whether to introduce more stimulus measures to a global economy that may be sliding back into recession. While the Federal Reserve on Aug. 10 extended its bond purchase program to shore up the U.S. economy, the European Central Bank shows little appetite to risk stoking inflation by loosening policy.
Double-Dip
As central bankers debate, bond yields keep sliding. The yield on the two-year U.S. Treasury fell to 0.48 percent on Aug. 17 and the yield on the Japanese 10-year security is close to the lowest since 2003. U.S. consumer prices excluding energy and food held at a 44-year low of 0.9 percent in June.
“I do not think the deflation and double-dip is the baseline scenario, but I think it’s the risk scenario,” Pimco Chief Executive Officer Mohamed A. El-Erian said on Aug. 5.
The German 30-year yield rose 3 basis points to 3.005 percent as of 11:24 a.m. in Frankfurt today. The return on 10- year Japanese debt was at 0.925 percent.
The inflation-fighting tradition pioneered by Germany’s Bundesbank, after the hyperinflation of the 1920s undermined confidence in the Weimar Republic, has left central banks unaccustomed to worrying about declining prices.
“Fighting inflation is the old Bundesbank mentality and part of the DNA of German bankers,” said Fredrik Erixon, director of the European Centre for International Political Economy in Brussels. “This has spread to a lot of other central banks in the past 20 years.”
‘Suddenly Poor’
By the end of 1923, prices were doubling every 49 hours and one dollar was worth more than a trillion marks. The experience paved the way for Adolf Hitler’s rise to power.
“My mother came from a rich family but due to the hyperinflation they were suddenly poor,” said Peter Koester, 87, who worked in the film industry with actor Peter Ustinov, and was a fighter pilot for the Luftwaffe in World War II. “Thank God those times are over,” he said in a telephone interview from Starnberg, Germany.
When the Allies and German politicians started to rebuild the war-ravaged economy in the 1950s, the Bundesbank’s inflation-fighting zeal helped cement an economic boom that established the nation’s currency as a global benchmark.
The hyperinflation of the last century casts a long shadow. Thomas Hoenig, president of the Fed bank in Kansas City, Missouri, keeps a framed bill from Weimar-era Germany on a wall near his office, and has opposed the near-zero rate policy that he says could fuel asset bubbles.
Hunting Havens
Some economists say the drop in benchmark bond yields reflects credit quality concern prompted by this year’s European sovereign debt crisis. As investors seek havens for their funds, the spread between Germany’s 10-year bund and Greece’s equivalent government bond last week rose to 800 basis points for the first time since June. The Bundesbank today boosted its growth forecast for this year to 3 percent, from a 1.9 percent prediction made in June.
“Renewed concerns about the fiscal position of peripheral euro zone countries is helping boost demand for bunds,” said Marco Annunziata, chief economist at UniCredit Group in London. “Deflation fears are unjustified. Inflation is not a threat yet, but deflation is extremely unlikely.”
Stripping out the change in consumer prices shows that the real yield on 10-year bunds is currently 0.64 percent, compared with the mean of 2.03 percent since January 2000.
Hoarding Cash
Policy makers will find it tougher to combat deflation because companies are hoarding cash and individuals are saving, according to El-Erian at Pimco. That reduction in private-sector spending makes government policies to stimulate the economy less effective, he said.
Consumers in the world’s largest economy saved 5.5 percent of their disposable income last year. In Germany, the rate was even higher, climbing to 11.4 percent.
“It’s fair to say the bond market is currently pricing in a significant risk of deflation,” said Derrick Wulf, a portfolio manager at Dwight Asset Management Co. which oversees $64.3 billion in Burlington, Vermont. “Not necessarily a unanimous expectation of deflation, but a significant risk.”
To contact the reporter on this story: John Fraher at jfraher@bloomberg.net
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