German inflation hits two-year high in October, good news for ECB

By Michael Nienaber

BERLIN (Reuters) - German inflation rose more than expected in October, reaching its highest level in two years, preliminary data showed on Friday, a welcome sign for the European Central Bank that its monetary policy is gradually eliminating the threat of deflation in Europe's biggest economy.

The ECB has unleashed unprecedented stimulus in recent years, slashing interest rates and pumping more than a trillion euros into the economy of the 19-member currency bloc through asset purchases.

A strong recovery in German inflation would give hawks like Bundesbank's president and ECB rate setter Jens Weidmann more grounds to argue for a reduction in the ECB's bond-buying programme.

German consumer prices, harmonised to compare with other European countries, rose by 0.7 percent on the year after an increase of 0.5 percent in September, the Federal Statistics Office said.

That was the highest inflation rate since October 2014 and stronger than a Reuters consensus forecast of 0.6 percent.

"Temperatures drop, inflation rises," KfW Bank economist Joerg Zeuner said. German inflation is likely to reach 2 percent at the beginning of next year, he said, as oil prices go up and the base effects from low energy costs fade out.

"There is a chance that monetary policy can slowly get back to normal soon," Zeuner added.

But other economists were less sure the pick-up in German inflation would lead the ECB to unwind its stimulus. They doubt that even German inflation will remain around 2 percent on a sustained basis, meaning the ECB will probably undershoot its target for the euro zone for the foreseeable future.

"This should encourage the ECB to maintain its current supportive policy stance for a long time to come," Capital Economics analyst Jennifer McKeown said.

Policymakers have said the central bank will provide stimulus until a sustained inflation rebound.

On a non-harmonized basis, German annual inflation picked up to 0.8 percent from 0.7 percent in September, the Statistics Office said. That was also the highest level in two years.

Energy prices remained the main drag on the headline figure, but they fell significantly less than in the previous months, a breakdown of the non-harmonized data showed.

In the state of Baden-Wuerttemberg, prices for gasoline and diesel fuel rose on the year for the first time since February 2013, regional data showed.

In a sign that a housing shortage in some urban areas is pushing up living costs, rents rose more strongly in October than in the previous months, the pan-German data showed.

The surprisingly solid German data suggests that euro zone inflation, due on Monday, is likely to come in at 0.6 percent in October, McKeown said.

That would also be higher than expected: Economists polled by Reuters so far have predicted the euro zone inflation rate edged up to 0.5 percent from 0.4 percent in September.

The ECB expects the bloc-wide inflation figure to stay below its target of just under 2 percent for some time, despite its massive stimulus.

(Reporting by Michael Nienaber; Editing by Paul Carrel, Larry King)