The wide inflation rate in Germany fell in March to its lowest level since last summer. Details showed that the price index mostly decreased due to energy and raw materials.

The key question is, has the deflationary process started? The overall rate decreased in March to 7.4% on an annual basis compared to 8.7% in February. It should be noted that the sharp decline in overall inflation is mainly the result of the negative base effect from energy prices, which rose in March last year when the conflict in Ukraine began. However, the underlying inflation pressure has not dissipated, and the fact that the monthly change in overall inflation was clearly above the historical average for March is not particularly encouraging.

Today’s report will allow to spin discussion that the surge in inflation across the eurozone was prolonged but mainly a transitoty shock of energy prices. If history is to be believed, today’s decline in overall inflation is the beginning of a more prolonged deflationary trend. However, as convenient as it may be to think so, inflation has long been a demand problem that has spread throughout the economy. The transfer of higher prices to production factors, although slowing down in recent months, is still in full swing. The expansion of profit margins and the increase in wages also fuel underlying inflationary pressure not only in Germany but throughout the eurozone.

Existing regional price components in Germany suggest that core inflation remains high. While energy prices continued to decline and were even negative for heating oil and fuel, food inflation continued to rise. Inflation in most other components remained largely unchanged. Given that energy consumption is more sensitive to price changes than food consumption, it now makes more sense for the European Central Bank to only consider overall inflation, which excludes energy but includes food prices when assessing underlying inflationary pressure.

As long as the current banking crisis remains under control, the ECB will continue to argue that it has tools to combat inflation and financial instability. The fact that there are still no signs of any deflationary process, discounting energy and raw material prices, as well as the fact that inflation is increasingly dependent on demand, will keep the ECB in a tightening regime.

The recent shock to the financial market in the last few weeks has been a clear reminder to the ECB that the increase in interest rates, albeit moderate, is already affecting economic activity, and a sudden or aggressive increase could cause more damage. Actually, with any further interest rate hike, the risk of something breaking increases. The ECB will likely act more cautiously in the coming months, despite the confidence after today’s report. In fact, the ECB is likely already in the final phase of tightening.