• Facebook
  • Facebook
  • Facebook
  • Facebook

Search This Blog

Visit our new website.

Monday, March 31, 2014

Expectations and pressure mount for ECB action

This could easily be a standard monthly headline. As before the past four or five ECB meetings, the questions of deflation and further easing are once again weighing on the ECB Governing Council and the markets.

Over the past month the market has come full circle from essentially ruling out any further ECB action to almost expecting some purchases of assets (both accompanied by the respective strengthening and then weakening of the euro exchange rate).

This was topped off today with the latest inflation data which showed that inflation in the eurozone has dropped to its lowest level for five years (annual rate of 0.5%).

A couple of points to note on this data:
  • While energy prices are still the largest driver of the contraction, unlike some previous months, core inflation (without energy, food prices or tobacco) has also fallen. This may encourage the view that the decreases are not simply due to short term shifts in commodity prices.
  • That said, the core inflation rates remain above where they were in November 2013 when the ECB previously cut rates.
  • Other national inflation data has been quite weak – Spain moved into outright deflation in March, while German inflation was running at only 1%.
  • As Gavyn Davies noted on twitter, the 0.5% rate falls outside of the ECB’s March projections for inflation this year and up to 2016. This raises questions about whether the inflation rate is still on the upward path forecast. Combine this will the volatility and tendency to strengthen of the euro and the ECB’s projections do not seem to be holding up too well.
The other aspect adding weight to expectations has been dovish comments by ECB members, notably by Bundesbank President Jens Weidmann. Many believe this has “opened the door” to significant action by the ECB. Open Europe’s Raoul Ruparel addressed this issue on his Forbes blog on Friday arguing:
“The real issue from a German perspective is not necessarily that the door was ever firmly closed (or open) but that we remain someway from the QE door and to get there would require carefully negotiating some politically and legally explosive obstacles.”
He concludes:
“In the end, I think we find ourselves in a fairly similar position to last month (albeit having gone through a cycle of over scepticism and now over optimism) – further action remains possible but not yet highly likely.”
This meeting will be another one to watch but so far the ECB seems strongly wedded to its new communication and forward guidance policy, which it believes can allow greater control over rates markets, it is not yet clear whether it is willing to abandon this approach or push it over the barrier into full on policy action.


Jesper said...

Why is increased costs seen as a good measure of increased capability of paying back borrowing and increasing consumer spending?

Higher costs do not make it easier to pay back borrowing nor to increase consumer spending.
Higher wages makes it easier to pay back borrowing and increases consumer spending.

Anonymous said...

PIIGS could have left the euro in 2009 and by now they'd recoup 50-60% of losses. Instead they've wasted years and piled up even more public debt. Total lunacy!
I can't understand what possible reason can euro-sheeple have to keep voting against their own best interests, but I suppose they'll always rather believe the Eurocrats rare than be responsible for themselves and take their chances.
There is no recovery and there is no hope for the euro (to waken) unless the ECB starts doing some real damage ("in order to save the village we had to destroy it").
Can't wait for the anti-EU parties to get elected to the EU parliament! There is no excuse for the EU parliament to not feature fistfights! We pay them too well for the poor performance they're delivering.

jon livesey said...

I don't see what you can do when so many people firmly believe that if you allow even a small rise in inflation, 1923 is right around the corner.

Doubly so when you consider how many people believe that the rise of Fascism was the result of hyperinflation, and not of the deflation and unemployment that followed it.

Rik said...

Blowing up a RE and Stockexchange bubble in Germany and Finland to give the South just enough time not to reform structurally seems the right recipe.
Bubbles on top of that that are likely to explode when the worldeconomy is in a crisis because the present US ones.

Rik said...

The EZ as a whole (monetary and fiscal policy wise combined) should finally set its priorities and stick to it.
Basically will that be internal devaluation or fighting possible deflation.

The two seem impossible to combine. And as Tinbergen already stated (decades ago) for economic policy to be effctive it should only try to achieve one thing.

Low inflation doesnot really seem to be a huge problem in the non-internal revaluation countries. Growth is low mainly because of other factors including the poor shape of the EZ in general, because of the South.
Might change lateron but simply doesnot look high priority stuff at the moment.

The internal revaluation (a rather moronic method btw imho, but nevertheless the one the EZ is supposed to be going for and effectively the only real policy that could restore competitiveness albeit in a very cruel way) countries would anyhow be in poor shape and not be growing in real terms. Simply for the reason they are in a horrible shape and have not yet bottomed out. Which means consumption is poor because of the uncertainty that gives. And because of that uncertainty and the poor consumption itself business is not investing.
Basically caused by the fact that the structural reforms simply take too much time and have not really bottomed out. Structural reforms as demanded by the markets btw. At the end of the day few people will be interested in the state of the structural reforms as agreed upon with Troikas etc., these can and are watered down whenever it is political conveneint anyhow. Countries like Spain and Greece need massive change much more than in the EZ recipe. Completely idiotic to think that the measures agreed upon will reduce nearly 30% unemployment to acceptable levels. You need a lot more reforms than that.
So still a lot of internal revaluation to be done. Made worse by the fact that in the PIIGS league there are worldwide now newcomers galore with much lower wages. In other words still a long way to go.

From there it looks like the priority is clear at least at this stage: Internal revaluation (for the South).

Starting from that priority as mentioned above deflation is part of the cure. The problems they have are mainly because of the slow pace of reforms not because deflation as such. Hard to see things going better if say Greece had a say 2% inflation.

On top of that policywise fighting low inflation would most likely be done via QE. A method whose effect imho is rather dubious. Extra liquidity seem to end up in the financial markets (via higher assetprices) and very little as real jobcreating investments and even less as extra spendingpower for the fast majority of the population.
On top of that the US shows that it clearly is able to blow substantial bubbles. Which are likely already present in Europe as well. Which when burst likely will create a new financial sort of crisis. Most bubbles in the last 2 decades did.

Overseen the whole picture. What most commentators seem to miss is that there should be overall a proper priority setting to make measures work. Otherwise (when measures try to be the best of 2 or more worlds they end up as being pretty ineffective.
From the 2 possible priorities internal revaluation should clearly be top. For the reasons mentioned above but also that they cause by far the most social tensions and therefor should be a short as possible (and as such are a danger for the whole rescue operation and the longer it will take the bigger the risk will get).
Anyhow QE (the most likely method) seems like a pretty dubious medicine seen the experience in the US with a lot of danger attached. With as added danger in Europe that simply the huge redistribution of wealth it causes will very likely create a lot of political problems.

Rollo said...

It is wrong to think of the Eurozone as a whole. It is disparate ships going in different directions and occasionally bumping together.
They are not in the same boat. Some are sinking.

Jesper said...

About QE in the US:

"But magically creating jobs out of the same thin air where the printed money came from was never part of the Fed’s strategy – nor could it actually do that."