The Financial Times on Germany 6

The Financial Times on Germany 6


WORLD NEWS: Germany's gamble with hefty VAT rise pays off

By Ralph Atkins in Frankfurt, Financial Times
Published: Jan 31, 2007

Germany's gamble with a sharp rise in value-added-tax this month appeared yesterday to have paid off with inflation rising by significantly less than expected. However, the impact on consumer spending and growth remains unclear.

Inflation in January rose to 1.8 per cent from 1.4 per cent in December on a harmonised eurozone basis, according to federal statistics office figures based on data from six German states.

The latest figure was below expectations and significantly lower than feared in the run-up to the controversial VAT increase, from 16 per cent to 19 per cent.

The lack of any great inflationary upswing in the eurozone's largest economy reduces the pressure on the European Central Bank to increase interest rates. Nevertheless the central bank will continue to fret about inflationary pressure in the pipeline - especially from German wage settlements, even though the lower than expected inflation figures will weaken the hand of trade unions.

After yesterday's German data, figures today could show eurozone inflation remaining unchanged at 1.9 per cent in January - exactly in line with the ECB's target of an annual rate "below but close" to 2 per cent.

Chancellor Angela Merkel pressed ahead with the increase in VAT - the biggest tax increase in German postwar history - in spite of widespread criticism from business and many economists, who feared it would stifle Germany's economic recovery.

The aim was to use the proceeds to plug holes in state and federal finances, but also to cut employer and employee contributions to unemployment insurance schemes.

Rule-of-thumb calculations had suggested that the VAT increase would increase Germany's inflation rate by 1.4 percentage points.

Disentangling the VAT effect from yesterday's figures is difficult because the rate of price rises has also been depressed by favourable crude oil price developments.

But Holger Schmieding, economist at Bank of America, said that so far the VAT increase only appeared to have pushed inflation up by 0.7 percentage points at most.