Category Archives: Euro area inflation

11/4/17: Euro Area Growth Conditions Remain Robust in 1Q 17

Eurocoin, Banca d'Italia and CEPR's leading indicator of economic growth in the euro area has slipped in March to 0.72 from 0.75 in February, with indicator remaining at its second highest reading since 2Q 2010.

Combined 1Q 2017 growth indictor is now signalling approximately 0.7% quarterly GDP growth rates, carrying the breakout momentum from previous quarters (see chart above). This brings most recent growth forecast over the 2001-2007 average.

From growth dynamics perspective, the pressure is now on ECB to start tightening monetary policy:

Inflationary pressures are still relatively moderate, but rising:

29/12/15: There Are Two Ways 2016 Can Play Out for Euro Area Bonds

With the pause in ECB QE over the holidays season, bond markets have been largely looking forward to 2016 and counting the blessings of the year past. The blessings are pretty impressive: ECB’s purchases of government bonds have driven prices up and yields down so much so that at the end of this month, yields on some USD1.68 trillion worth of Government bonds across 10 euro area countries have been pushed below zero.

Per Bloomberg chart:

Value of bonds with yields below ECB’s -0.3% deposit rate, which makes them ineligible for purchases by the ECB, is $616 billion, just shy of 10 percent of the $6.35 trillion of bonds covered by the Bloomberg Eurozone Sovereign Bond Index. As the share of the total pool of marketable European bonds, negative yield bonds amounted to more than 40% of the total across Europe at the start of December (see here:

Two questions weigh on the bond markets right now:
1) Will the ECB expand the current programme? Market consensus is that it will and that the programme will run well beyond 1Q 2016 and spread to a broader range of securities; and
2) Will low inflation environment remain supportive of monetary easing? Market consensus is that it will and that inflation is unlikely to rise much above 1% in 2016.

In my view, both consensus positions are highly risky. On ECB expectations. Setting aside inflationary dynamics, ECB has continuously failed to ‘surprise’ the markets on the dovish side. Nonetheless, the markets continued to price in such a surprise throughout 2015. In other words, current pricing is probably already reflecting high probability of the QE extension/amplification. There is not much room between priced-in expectations and what ECB might/can do forward.

Beyond that, my sense is that ECB is growing weary of the QE. The hope - at the end of 2014 - was that QE will give sovereigns a chance to reform their finances and that the economies will boom on foot of cheaper funding costs. Neither has happened and, if anything, public finances are remaining weak across the Euro area. The ECB has been getting a signal: QE ≠ support for reforms. And this is bound to weigh heavily on Frankfurt.

On inflationary side, when we strip out energy prices, inflation was running at around 1.0% in November and 1.2% in October. On Services side, inflation is at 1.2% and on Food, alcohol & tobacco it is at 1.5%. This is hardly consistent with expectations for further aggressive QE deployment and were ECB to engage in more stimulus, any reversion of energy prices toward the mean will trigger much sharper tightening cycle on monetary side.

The dangers of such tightening are material. Per Bloomberg estimate, a 1% rise in the U.S. Fed rates spells estimated USD3 trillion wipe-out from the about USD45 trillion valuation in investment-grade bonds issued in major currencies, including government, corporate, mortgage and other asset-backed securities tracked by BAML index:

Source here.

European bonds are more sensitive to the ECB rate hikes than the global bonds are to the Fed hike, primarily because they are already trading at much lower yields.

Overall, thus, there is a serious risk build up in the Euro area bond markets. And this risk can go only two ways in 2016: up (and toward a much worse blowout in the future) or down (and into a serious pain in 2016). There, really, is no third way…

3/12/15: Updating that Euro Donkey of Global Growth

While Mario Draghi kept talking justifying the course of ECB policy decisions (or indecisions, as some might want to put), the ECB released staff projections for GDP growth. Here they are, in full glory:

Source: @fwred 

So, that poverty of low aspirations has now been firmly replaced by the circular forecasts: 2015: 1.5% to 1.4% to 1.5%; 2016: 1.9% to 1.7% to 17.%, 2017: 2.1% to 1.8% to 1.9%, whilst inflation expectations are now ‘anchored’ in the proverbial ditch. Meanwhile, Mr Draghi says:

Just as the Euro went through the roof on USD side and with it, Europe's 'exports-led recovery' went belly up.

Though never mind. The bigger headache (that few Europeans can even spot) is that the ECB forecasts are talking about 'growth' at below 2 percent with all this QE and with inflation at extremely low end. Which makes the whole exercise of monetary and fiscal policies activism... err... academic. For as far as I know, no donkeys are allowed to compete in Kentucky Derby. 

23/3/15: Deflation… Dumbflation… It’s Real Purchasing Power That Matters

I have written in the recent past about the bogus debate surrounding the 'threat of deflation' in the euro area. You can see my view on this here in the context of Ireland: and here in the broader context:

And now Bloomberg weighs in with the similar:

To quote: "The strengthening recovery [in the euro area] should add some inflationary pressure — although readings are likely to remain in negative territory for some months, with lower energy prices still feeding through the production pipeline. This month, the ECB revised down its 2015 inflation forecast to zero. Assuming nominal earnings grow at the same pace seen over the last few quarters, the upward trend in real pay should persist in 2015.

Households are likely to react — even if with some lag — to the purchasing-power bonus. Household consumption, which makes up about 55 percent of GDP, has been somewhat muted lately, only contributing to growth by an average 0.1 percentage point over the last seven quarters. That’s less than half what it used to bring in during the pre-crisis years. The re-emergence of this large growth driver should help to strengthen the 2015 recovery. Negative inflation is a welcome shortcut, meaning the region doesn’t have to wait for a decline in unemployment to see a revival in domestic consumption."