Inflation vanishes

January 5, 2015

Draghi, President of the European Central Bank (ECB) waits for the start of the European Banking Congress in the Old Opera house in Frankfurt

German inflation figures for December will presage the euro zone number on Wednesday, together offering one of the final pieces of the jigsaw for the European Central Bank before its late January policy meeting at which it could commence a quantitative easing government bond-buying programme.

Given the dramatic fall in the price of oil, inflation in Germany is predicted to fall to just 0.2 percent while the overall euro rate could turn negative. That would make QE very hard to argue against.

The euro has hit a nearly nine-year low versus the dollar this morning below $1.19 as markets firmly price in further ECB action, fuelled by Mario Draghi’s Friday interview in a German newspaper in which he said the risk of the ECB failing to meet its price stability goal had risen and action may be needed to meet that mandate.

That sounds dry but the central bank has spent its entire existence up to now saying it would deliver price stability.

Draghi has made it clear he will move with a majority behind him so opponents of QE on the Governing Council will not have the numbers to stop it. The question is whether he can marshall his forces to agree on an unlimited programme or whether the likes of Bundesbank chief Jens Weidmann will succeed in limiting its scope.

If it is the latter it is unlikely to do the trick in reviving a moribund euro zone economy.
The latest talk is that the ECB could require central banks in countries such as Greece or Portugal to set aside extra money or provisions to cover potential losses from any bond-buying, reflecting the riskiness of their debt and putting the onus on national central banks rather than the ECB.

Such a move could help secure German support but it would almost certainly limit the size of the programme. There will be particular questions about Greece now. Could it take on that sort of burden particularly if a Syriza-led government has turned its back on austerity and bailout commitments? And what of the moral hazard involved in buying the bonds of a country which could be about to abandon its commitments to cut debt?

Greek election campaigning will get underway in earnest with just 20 days until elections. The latest opinion poll shows left-wing, anti-bailout Syriza’s poll lead has narrowed slightly. Syriza leader Alexis Tsipras said the ECB could not exclude Greece from a QE programme.

Germany’s deputy leader, Sigmar Gabriel, said Berlin wanted Greece to stay in the euro zone after Der Spiegel magazine reported that the government had shifted its view and now believed the euro zone would be able to cope with a Greek exit.

With a banking union now in place, most Greek debt held by other euro zone governments and EU institutions and the ECB poised to buy lots of euro government bonds there are good reasons to think that Greece can no longer threaten the currency bloc as a whole, no matter what happens in Athens. But it remains a risk most would prefer not to take.

We’ll get a good idea of how rampant consumer spending was in Britain over the Christmas period. Britain’s biggest department store group John Lewis puts out a trading statement today and Marks & Spencer, Sainsbury and Tesco follow later in the week.

Russia is on its new year holiday so markets are thin. The rouble has opened about 5 percent weaker against the dollar, reflecting a bleak prognosis.

Unless the price of oil bounces markedly or Vladimir Putin walks away from Ukraine thereby loosening western sanctions Russia could be heading for a serious economic fall. Reserves are being burned defending the currency. They are sufficient for now but without hefty tax increases, public spending cuts and/or a higher pension age the outlook for 2016 and beyond is much gloomier.

By then foreign currency reserves and the country’s rainy day funds could be exhausted and if oil keeps dropping – it’s now not much above $55/barrel whereas Russia needs something around $100 — that day will be hastened.

With interest rates at a punitive 17 percent, the government is forecasting a deep recession this year coupled with double digit inflation. Two banks have already been bailed out and the economic slump and unstable rouble could well push others into strife.


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