German inflation drops to 2.3% in June, well below forecasts, as oil prices retreat and fuel subsidy expires

Surprise drop beats forecasts

Germany's annual inflation rate fell to 2.3% in June, the Federal Statistical Office said in its flash estimate on Tuesday. Economists polled by news agencies had expected the rate to hold steady at 2.6%. Month-on-month, prices declined 0.3%.

The drop was driven overwhelmingly by energy costs. Energy prices were up 3.4% from a year earlier, a sharp deceleration from the 6.6% recorded in May and roughly 10% in April, when the Iran war had sent oil prices soaring. Food inflation held at 0.4%, while services prices rose 3.1%, both unchanged from May.

The unexpectedly clear decline in inflation is good news for consumers.

The tankrabatt effect

The federal government introduced a fuel subsidy on 29 May that lowered the energy tax on petrol and diesel by about 17 cents per litre. The measure, which expires today, shaved about a quarter of a percentage point off the headline rate, according to a Bundesbank estimate cited by Handelsblatt. ADAC data showed Super E10 petrol was on average almost 6% cheaper in the first 29 days of June than in May, while diesel prices fell nearly 9%.

An Ifo analysis suggested that not all of the diesel tax cut was passed on to consumers, meaning the disinflation also reflects the underlying drop in crude oil prices. The expiry of the subsidy is expected to push the rate higher again in July.

Inflation fell in June mainly because of the lower oil price. In July, however, it should rise again because the fuel subsidy will then disappear.

Core inflation remains stable

Stripping out food and energy, core inflation was 2.5% in June, unchanged from May. The persistence of services inflation at 3.1% and a 0.4% rise in food costs highlight that underlying price pressures have not materially eased. Import prices surged in May at their fastest pace since late 2022, raising the risk that businesses will eventually pass higher input costs through to consumer prices.

Economists at the German Council of Economic Experts (the "Wirtschaftsweise") still expect the full-year average inflation rate to climb to 3.0% in 2026, up from 2.2% in 2025. The Iran war continues to unsettle household spending, a key pillar of the economy.

Energy prices are falling, and suddenly the world looks better again. That supports the prospect that the inflation rate has left its peak behind. The prerequisite, however, is that the Middle East conflict does not flare up again.

ECB walking a tightrope

The European Central Bank responded to the Iran-driven oil shock by raising its key interest rates in June for the first time in almost three years. ECB board member Isabel Schnabel recently signalled that further hikes are on the table. The central bank does not expect to return to its 2% inflation target until 2028.

[The ECB expects] its price target of 2% only in 2028, and further rate increases are in prospect.

The June dip gives the ECB some breathing room, but economists warn that second-round effects from earlier energy spikes are still working their way through the system. The Commerzbank and ABN Amro economists both cautioned that a return to 2.0% is unlikely before 2027.