Thursday 23 November 2017

Daily Market Update: Euro zone inflation back in negative territory, reinforcing the case for strong ECB policy action

Frankfurt am Main, western Germany. / AFP / ODD ANDERSENODD ANDERSEN/AFP/Getty Images
Frankfurt am Main, western Germany. / AFP / ODD ANDERSENODD ANDERSEN/AFP/Getty Images

Simon Barry

Yesterday’s February inflation data from the euro zone were weaker than expected and have reinforced expectations that the ECB will provide further stimulus at its next meeting on March 10th.

Headline inflation fell back into negative territory, with the February reading of -0.2% marking a 12-month low and a 0.2% shortfall relative to market expectations for a flat reading. Significantly, the source of the downside surprise was on the core measure, which was two-tenths weaker than expected in falling to a 10-month low of 0.7% (from 1% in January). This leaves both headline and core inflation running below the path set out in the latest (December) set of ECB staff projections. Markets are already priced for meaningful action at this month’s policy meeting, with close to 15bps of a deposit rate cut priced into interest rate markets.

Yesterday’s inflation numbers, taken together with the latest indicators on growth which are pointing to some early-year slippage in momentum, reinforce the case for a significant policy response on Thursday week. The prospect of additional ECB action has been weighing on the euro’s performance on the exchanges, with Eur/Stg dropping a notable 1.1% to open at 78p while Eur/USD is down some 0.6% to open at around $1.0875.

Speaking of central bank action, Asian equity markets have had a positive session overnight following the latest stimulus move from the PBOC. The Chinese central bank yesterday announced a cut in its reserve requirement ratio (the amount of cash that banks must hold as reserves) by 0.5%. The move has been followed by February PMI data which were generally softer than expected: two measures of manufacturing weakened relative to January, as did the official non-manufacturing indicator. Indications of continued slowing in Chinese growth point to the likelihood of further PBOC easing and the likelihood of further downward pressure on the Chinese currency as we look ahead.

At home, initial bond market reaction to the Irish election has been subdued. Irish government 10-year yields are little changed from levels seen on Friday at around 0.91%, which at the margin represents some slight under performance relative to sovereigns elsewhere in the euro zone, but nothing to suggest that investors are overly anxious about the political / policy outlook, for the time being at least. Echoing the benign post-election price action, ratings agency Fitch yesterday said that the inconclusive result “does not alter its expectation that the next government will pursue deficit reduction”. However, the agency went on to caution that “protracted political uncertainty, an unstable government, or reliance on more radical political elements could be negative if they reduce the authorities' ability to respond to downside fiscal or economic risks”. Investors, market analysts and voters indeed remain in wait and see mode as they monitor soundings from the political system regarding possible alternative governments.

In the meantime, available indicators on the health of the economy continue to paint a very favourable picture. Yesterday brought news of a very strong start to the year for Irish retail sales, with total volumes rising 4.1% m/m in January, taking them to an 8-year high – their highest level in fact since their pre-crisis peak seen in January 2008. Motor trade sales were particularly strong (up 9.1%m/m) but trends in exmotor sales volume also continue to look very solid, with annual growth of 6.4% y/y in January building on the 6.1% annual gain recorded in 2015.

Looking to the day ahead, there are several manufacturing survey releases. Global manufacturing has been on the back foot in recent quarters, but January saw some encouraging data released on the sector in the US (manufacturing payrolls, manufacturing production, and durable goods orders all recorded solid growth). The US manufacturing ISM is expected to tick up from 48.2 to 48.5 in February, but remain below 50 (which signifies contraction). In the UK, the manufacturing PMI is expected to dip from 52.9 to 52.3 in February. The updated February manufacturing PMI is also published for the Eurozone and is expected to remain unrevised at 51.0.

US Wards total vehicle sales are expected to advance from 17.5m to 17.7m in February, well above the 30 year average of 15.1m.

In the Euro Area, the unemployment rate is announced for January and expectations are for it to remain at 10.4%. Unemployment has been falling gradually but steadily from its early-mid 2013 high of 12.1%.

As part of a new communications policy, the ECB governing council will not make any public pronouncements on monetary policy from this Thursday until the ECB’s policy announcement on March 10th. Therefore, any speaking engagements from members of the ECB governing council before then will see close attention. Executive governing council member Sabine Lautenschlaeger gives a keynote address in New York today

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