Euro zone inflation to fall further?

July 31, 2014


Euro zone inflation is the big figure of the day. The consensus forecast is it for hold at a paltry 0.5 percent. Germany’s rate came in as predicted at 0.8 percent on Wednesday but Spain’s was well short at -0.3 percent. So there is clearly a risk that inflation for the currency bloc as a whole falls even further.

The Bundesbank has taken the unusual step of saying wage deals in Germany are too low and more hefty rises should be forthcoming, a sign of its concern about deflation. But the bar to printing money remains high and the European Central Bank certainly won’t act when it meets next week. It is still waiting to see what impact its June interest rate cuts and offer of more long-term cheap money to banks might have.

German retail sales, just out, have risen 1.3 percent on the month in June after a fall in May.

One problem for the ECB will be how to remain in ultra-stimulative mode once U.S. interest rates start to rise. The Federal Reserve is on course to end its QE programme in October and repeated its message yesterday that is in no hurry to raise interest rates.
No tightening is expected before mid-2015 but as the realization grows that it is coming, it could start to have an impact. Strong U.S. GDP data yesterday and the Fed’s upgrading of its assessment of the U.S. economy pointed in that direction. There is little chance of euro zone long-term interest rates decoupling from U.S. ones if they start rising.

UK consumer confidence fell for the first time in six months in July, according to an overnight survey from GfK. The Nationwide building society said UK house prices rose at their slowest pace in 15 months in July and Bank of England policymaker Ben Broadbent said the edge was coming off the housing market. But he said he saw a case for an earlier rate rise though any tightening cycle would be “limited and gradual”.

The Ukrainian parliament meets for an extraordinary session to vote on austerity budget amendments with money running short for energy and to pay for the army which is battling separatists in the east.

Prime Minister Arseny Yatseniuk tendered his resignation when parliament refused to pass the laws last week but it has not been accepted so far. There may be a confidence vote called on him and his government. Yatseniuk has told lawmakers to pass the austerity measures in an attempt to keep a bailout deal with the International Monetary Found in place and said the country would default if the laws are defeated.

Russia has begun to retaliate against tough EU sanctions, banning most fruit and vegetable imports from Poland and threatening to extend that to the entire European Union. Moscow also warned of higher energy prices for Europe.

In turn, the United States is trying to ensure that Asia and other parts of the world don’t provide alternative sources of finance for Russian banks and the G7 countries put out a statement last night saying further sanctions were in the pipeline if Russia doesn’t change course on Ukraine.

Banks and investors in Asia appear to be reluctant to get involved. This leaves the Russian central bank as the only obvious alternative, apart from Chinese currency bonds where borrowing costs are rising and the market is too small to plug the gap left by Western capital markets. With nearly $500 billion in FX reserves the central bank can hold the line for quite some time but no central bank likes burning its reserves.

The European Commission published the names last night of eight Russians, including some of President Vladimir Putin’s associates, and three companies which will have their assets frozen as part of sanctions against Russia’s actions in eastern Ukraine. That brings the total of people targeted to 95 and organizations to 23.

Malaysian Prime Minister Najib Razak meets Dutch Prime Minister Mark Rutte in The Hague to discuss the Ukraine air crash, which killed 195 Dutch citizens.

A couple of messes to give the markets pause for thought today. Argentina will default on its debt after talks with holdout creditors broke down on Wednesday. Broader concern has so far been notable by its absence, partly because we’ve been here more than once before.

Portuguese bank BES’s new management will seek to raise capital to bolster its finances after admitting that laws may have been broken during a tumultuous six months in which it lost 3.6 billion euros. The question is who is going to stump up and whether the government and central bank may eventually have to step in.

The central bank said it would prefer if capital were raised from private sources, but that the country does have funds for a public bailout if needed.

World trade talks are also teetering, again not for the first time. A group of World Trade Organization members has informally discussed adopting a global overhaul of customs rules without India if New Delhi goes ahead with threats to block the deal, sources told Reuters.

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