MacroScope

Euro zone inflation falls again; economists base ECB rate cut calls on deja vu

Euro zone inflation has dipped again and some forecasters are hedging their bets on the policy response by saying the European Central Bank could either cut rates this week or sometime in the next two months.

That lack of conviction, although not a recent phenomenon, is driven by memory of the ECB’s surprise cut in November after a similar drop in inflation and a nagging belief that things have not worsened enough in the interim to warrant another.

Only two of 76 analysts - Barclays and IFR Markets – in a Reuters poll conducted before news on Friday that January euro zone inflation fell to 0.7 percent said the ECB would trim its refinancing rate below 0.25 percent this week.

Now a few more, including Deutsche Bank and RBS say they will. While many economists say the decision is a close call, most lack conviction over whether it will do any good.

Money market traders aren’t convinced either, despite the fall in bond yields in recent days and the sell-off in emerging market assets.

ECB deflation risk denial has echoes of 2009

Euro zone policymakers like to talk. They often contradict each other at separate speaking engagements on the same day. But they have struck a chorus in recent weeks, asserting that deflation is not a threat.

Members of the ECB Governing Council have been particularly vocal, insisting they will not have to alter policy to counter falling prices.

Jan 9: Mario Draghi says the euro zone may “experience a prolonged period of low inflation” — steering clear of even mentioning the word deflation.

A week before emerging-market turmoil, a prescient exchange on just how much the Fed cares

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The last seven days has been a glaring example of fallout from the cross-border carry trade. That’s the sort of trade, well known in currency markets, where investors borrow funds in low-rate countries and invest them in higher-rate ones. Some $4 trillion is estimated to have flooded into emerging markets since the 2008 financial crisis to profit off the ultra accommodate policies of the U.S. Federal Reserve, Bank of Japan, European Central Bank and the Bank of England. Now that central banks in developed economies are looking to reverse course and eventually raise rates, that carry trade is unraveling fast, resulting in the brutal sell-off in emerging markets such as Turkey and Argentina over the last week.

The Fed’s decision on Wednesday to keep cutting its stimulus effectively ignores the turmoil in such developing countries. And while the Fed may well be right not to overreact, it makes one wonder just how much attention major central banks pay to the carry trade and its global effects — and it brings to mind a prescient exchange between some of the brightest lights of western economics, just a week before emerging markets were to run off the rails.

On January 16, minutes before Ben Bernanke took the stage for his last public comments as Fed chairman, the Brookings Institution in Washington held a panel discussion featuring former BoE Deputy Governor Paul Tucker, Harvard University professor Martin Feldstein and San Francisco Fed President John Williams. They were asked about the global effects of U.S. monetary policy:

Relief from UK services inflation seen fleeting

British inflation dipped to 2 percent  in December – its lowest since November 2009 and within the Bank of England’s target. Part of the move was driven by a fall in prices in Britain’s services sector – which constitutes more than three quarters of the country’s output.

Services inflation, which makes up around 47 percent of the consumer price index, eased to  2.4 percent in December – also its lowest since November 2009. Goods inflation – which is more sensitive to global markets than domestically generated services inflation – edged up to 1.7 percent last month. But it has also come down in recent months as a strengthening sterling pushed down import prices.

The fall has helped the case for the Bank of England to keep interest rates at a record low of 0.5 percent, also giving the government a boost ahead of elections next year. Analysts say weak wage growth may be a reason for more subdued services inflation, but given the strength of the labor market, this trend could be fleeting.

Hollande’s moment of truth

This afternoon, French President Francois Hollande will expand upon his New Year announcement that French companies who agree to hire more workers could pay lower labour taxes in return and find themselves less tied up in red tape. Unemployment is running near to 12 percent and Hollande’s vow to get it falling by the end of 2013 fell short.

Unfortunately, the announcement has been eclipsed by his threat of legal action after a French magazine reported he was having an affair with an actress. France tends to overlook its politicians’ peccadilloes but with the economy in a hole, Hollande risks facing the charge that he should be focusing squarely on that.

To complicate matters his partner, Valerie Trierweiler, has been admitted to hospital following the reports. She will stay there for a number of days yet.
Given this is one of only two news conferences that Hollande has promised to give each year it’s hard to see how he can avoid it being hijacked by his personal life. As boxing promoter Don King was fond of saying: there are two chances, slim and none and Slim just left town.

That sinking feeling

Euro zone inflation, or deflation, is the focus of the moment.

Germany’s HICP rate fell to 1.2 percent last month, Italy’s hit 0.6 percent and Spain’s just 0.3 in December (not to mention Greece’s -2.9 percent). Today we get the figure for the euro zone as a whole. Forecasts for it to hold at 0.9 percent may now look a little toppy.

It’s too early for any dramatic moves but the European Central Bank, which has a policy meeting on Thursday, may well be pushed into easing policy if inflation refuses to pick up and/or the banks clam up ahead of this year’s health tests.

A shock fall in euro inflation to 0.7 percent prompted an interest rate cut to 0.25 percent in November followed by a chorus of denials that deflation was a threat. ECB chief Mario Draghi adhered to that last week but added that he and his colleagues had to make sure inflation didn’t get stuck in the “danger zone” below one percent.

Data to shape ECB week

Euro zone service sector PMIs and German inflation (with the euro zone number to follow on Tuesday) will lay the ground for the European Central Bank’s first policy meeting of the year.

The surveys are likely to show the currency bloc ended the year on a reasonably robust note with Germany leading the way as always, Italy and Spain showing signs of life and France looking worryingly weak.

Ireland’s reading is already out and has posted its fastest services growth in seven years. Much more importantly for the world, growth in China’s services industries slowed in December, confirming that the world’s second-largest economy lost steam at the end of last year.

from Global Investing:

The hryvnia is all right

The fate of Ukraine's hryvnia currency hangs by a thread. Will that thread break?

The hryvnia's crawling peg has so far held as the central bank has dipped steadily into its reserves to support it. But the reserves are dwindling and political unrest is growing. Forwards markets are therefore betting on quite a sizeable depreciation  (See graphic below from brokerage Exotix).

 

The thing to remember is that the key to avoiding a messy devaluation lies not with the central bank but with a country's households. As countless emerging market crises over decades have shown, currency crises occur when people lose trust in their currency and leadership, withdraw their savings from banks and convert them into hard currency.  That is something no central bank can fight. Now Ukraine's households hold over $50 billion in bank deposits, according to calculations by Exotix. Of this a third is in hard currency (that's without counting deposits by companies).  But despite all the ruckus there is no sign of long queues outside banks or currency exchange points, scenes familiar to emerging market watchers.

Brussels looks warily at German surplus

Barring a last minute change of heart, the European Commission will launch an investigation into whether Germany’s giant trade surplus is fuelling economic imbalances, a charge laid squarely by the U.S. Treasury but vehemently rejected by Berlin.

This complaint has long been levelled at Germany (and China) at a G20 level and now within the euro zone too. Italian Prime Minister Enrico Letta urged Berlin this week to do more to boost growth.

Stronger German demand for goods and services elsewhere in the euro zone would surely help recovery gain traction. The counter argument is that in the long-run, only by improving their own competitiveness can the likes of Spain, Italy and France hope to thrive in a globalised economy.

French travails

The Bank of France’s monthly report forecasts growth of 0.4 percent in the last three months of the year, up from an anaemic 0.1 percent in the third quarter. That still makes for a fairly doleful 2013 as a whole.

France is zooming up the euro zone’s worry list, largely because of its timid approach to labour and pension reforms. Spain has been much more aggressive and is seeing the benefits in terms of rising exports (and, admittedly, sky-high unemployment). So too has Portugal.

Tellingly, both the Iberian countries have had the outlook on their credit ratings raised to stable in recent days while S&P cut France’s rating to AA from AA+. It remains at a far stronger level but the differing directions of travel are clear.