12.05.202209:40 Forex Analysis & Reviews: German economy faces looming stagflation

Germany, Europe's economic powerhouse, is facing an uncertain future. Its economy may be in the early stages of a stagflation - a period of high inflation coupled with economic stagnation, according to a senior adviser to Finance Minister Christian Lindner. Economic growth did not accelerate after the easing of COVID-19 restrictions, while inflation has become persistent, against expectations of market players.

Germany, Europe's economic powerhouse, is facing an uncertain future. Its economy may be in the early stages of a stagflation - a period of high inflation coupled with economic stagnation, according to a senior adviser to Finance Minister Christian Lindner. Economic growth did not accelerate after the easing of COVID-19 restrictions, while inflation has become persistent, against expectations of market players.

Currently, Germany is facing a high risk of stagflation. Some experts assume the country may already be mired in its early stages. The government is expected to present its plans to normalize the situation and respond with strong measures.

Lars Feld, a professor of economic policy who advises German Finance Minister Lindner, has recently presented a new strategy paper outlining the government's finance policy response to the war in Ukraine, as well how it plans to address the lingering effects of the coronavirus pandemic. The paper, entitled "Finance policy during the turning point - strengthen growth and avoid inflationary impulses," details plans to focus on stabilizing Europe's biggest economy, accelerate growth and boost investments. Feld also called for building a "fiscal buffer" to help cope with any future crises.

Christian Lidner noted that Russia's actions, as well as supply chain problems and production bottlenecks, have significantly influenced the economic situation in Germany. "The prices of many good and services are rising more quickly that at any time in the past four decades," he added, stating that it was a matter of concern.

The president of the European Central Bank, Christine Lagarde, has recently signalled the regulator is planning to enact measures to bring high inflation under control. Currently, inflation is 4 times higher than the target level. "The first rate hike, informed by the ECB's forward guidance on the interest rates, will take place some time after the end of net asset purchases," Lagarde said on Wednesday. "We have not yet precisely defined the notion of 'some time', but I have been very clear that this could mean a period of only a few weeks."

Risky assets were mixed amid the current situation. EUR/USD failed to extend its upside movement after stabilizing at 1.0470. Expectations of more aggressive ECB policy have failed to give support to the pair. Geopolitical tensions remain the main threat for the European economy, exacerbated by supply chain issues in eurozone countries. These factors would continue to limit the upside potential of risky assets. To stop the downtrend, bullish traders would need to hold on to the closest support level at 1.0470. If the pair breaks below this level, it will likely fall towards the new yearly lows at 1.0420 and 1.0390. To begin a correction, EUR/USD would have to climb above 1.0525 and break above 1.0675, which was unsuccessfully tested recently. From there, the pair could move towards 1.0640 and 1.0690.

The pound sterling's situation is dire, with bulls having no chance to regain the initiative. The weak economy, looming recession, and an inflation rate of 7.0% are pushing GBP down - there are no indications that the situation will improve in the near future. Bullish traders managed to hold on to 1.2185 and are trying to steer the pair above 1.2245. However, these attempts are unlikely to succeed. Traders are advised to open short positions in the short-term during upward corrections. A breakout about 1.2245 would push the pair towards 1.2320 and 1.2400, while a breakout below 1.2185 would increase bearish momentum, opening the way towards new lows at 1.2120 and 1.2070. Below these levels lies the support level of 1.2030, which would be tested very quickly if the UK economy continues to get weaker.