Friday 19 January 2018

Rate hikes on hold as inflation trails euro zone growth without

The European Central Bank’s headquarters in Frankfurt is illuminated in the night sky. The European economy is growing strongly but inflation remains low. Photo: Bloomberg
The European Central Bank’s headquarters in Frankfurt is illuminated in the night sky. The European economy is growing strongly but inflation remains low. Photo: Bloomberg
Colm Kelpie

Colm Kelpie

Eurozone inflation data for December will likely make for frustrating reading for Mario Draghi and his fellow central bankers.

The Eurozone economy is growing strongly. Just this week manufacturing data for the bloc showed activity was rising at its fastest pace in 20 years.

And yet, inflation still remains far off the European Central Bank's target of 2pc or close to 2pc.

Inflation slowed as expected last month, growing by just 1.4pc year-on-year, compared with 1.5pc the previous month, due to smaller increases in food and energy prices.

Once those components are stripped out, so-called "core" inflation was stable at 1.1pc - still far off the ECB target.

That means that, at least in theory, there is little pressure on the ECB to unwind further its massive bond-buying programme. Until it does that, interest rate rises remain a remote possibility.

Last month the ECB raised its growth and inflation forecasts as the bloc's recovery becomes increasingly broad-based. But it sees inflation falling short of target into 2020 as high unemployment keeps a lid on wages. The Frankfurt-based central bank, which targets inflation at just below 2pc, sees price growth slowly accelerating over the coming years and hitting 1.7pc in 2020.

To revive growth, the ECB has used its entire arsenal.

It has cut rates into negative territory, given banks nearly unlimited access to cheap funding, and bought over €2trn worth of bonds to depress borrowing costs.

If the economy is in recovery mode, why has inflation remained so stubborn?

"The strong euro in December will have pushed down the price of imports, which would have driven down inflation which could contribute to the fall this month," Pablo Shah, an economist with the London-based Centre for Economics and Business Research (Cebr) told the Irish Independent.

"Theoretically, high growth would be followed by high inflation. There are loads of different theories as to why it hasn't really been happening across developing economies in recent years. There are theories that ageing populations could have a role to play in pushing down the long-term rates of inflation, and there's also theories about how the nature of consumer spending is changing with more shopping online, creating disinflationary pressures.

"It is certainly not what you would expect."

The ECB in October announced it was cutting its massive stimulus plan but extending it to run until September.

The Frankfurt-based central bank opted to cut its bond buying programme to €30bn per month from the current figure of €60bn, as of this month. But it extended the scheme's lifespan by a further nine months, signalling to investors that despite strong growth, work must continue given the low inflation environment.

Mr Shah said utterances by ECB policy makers this week could actually lead to lower inflation this year.

"Previously we've assumed that below target would mean that the ECB would be more hesitant towards lifting interest rates and tightening monetary policy going forward, but there have been a few governors that said in interviews this week, that they might consider tightening monetary policy in 2018 even if inflation remains below target," Mr Shah said.

Meanwhile, US job growth slowed more than expected in December amid a decline in retail employment, but a pick-up in monthly wage gains pointed to labour market strength that could pave the way for the Federal Reserve to increase interest rates in March.

The US dollar was slightly stronger against a basket of currencies.

Like in the Eurozone, attention in the US will turn to inflation next week.

"Once the dust settles on the post-employment report move in the dollar, the market will turn its attention quite quickly to events next week," said John Moclair, Head of Global Customer Group, Bank of Ireland Global Markets.

"Friday's US inflation print looms large. The Fed has previously expressed concern about the lack of inflation in the US economy, and so any meaningful signal here could be a key driver for the dollar in the coming weeks. In addition, political risk returns as congress must pass legislation by January 19 to fund the Government or else risk a partial shutdown."

Irish Independent

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