Will the ECB ease again?

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by Shaun Richards

The events of this morning and indeed overnight really highlight the problems ahead for the Euro area and hence the European Central Bank. The new Covid-19 scare has two facets which affect it. Firstly the increasing restrictions and in Austria’s case new lock down and secondly the additional fears about a new strain from South Africa. Switching to the economics both moves are contractionary and maybe very contractionary if this is acted upon.

German Health Minister Spahn: Coronavirus Situation Is Dramatic, More Serious Than At Any Other Time In Pandemic So Far ( @LiveSquawk )

On Wednesday Executive Board member Fabio Panetta was more accurate than he realised by opening his speech with this.

The long and rocky road out of the pandemic is creating challenges for monetary policy.

Although he then rather dropped the ball here.

Following years of too-low inflation and policy oriented at addressing deflationary risks, we are now in an environment of two-way inflation risks and heightened short-term volatility .

Inflation risks are presently one-way. The next bit was a probably unintentional critique of the communications shambles at the Bank of England.

In this environment, central banks must clarify their reaction function, so that market expectations remain aligned with their policy intentions.

In a way that applies in a more minor sense to the ECB with markets somehow summoning up enthusiasm for it to raise interest-rates next year. As you can see below he has no intention of acting against the inflation spike.

Today, I will argue that globally we are seeing a mix of demand and supply shocks, but in the euro area supply constraints dominate to a much greater degree than in some other major economies. This is leading to a temporary spike in the price level, which acts as a “tax” on consumption and a brake on production, over time generating effects akin to an adverse demand shock.

It would not take a lot more of that sort of logic for him to ease policy again. The next part is even more extraordinary in my view.

In this context, so long as higher short-run inflation does not feed into inflation expectations and wage and price-setting in a destabilising way, monetary policy should remain patient.

So actual price rises are fine as long as something that is in the imagination and frankly is impossible to measure is in his opinion under control? The events of the last 24 hours have shown we sometimes can barely see a few days ahead but he wants to rely on something that is dubious even in more certain times. The bit about wages is very bi-polar because policy is set to make people better off and wages higher but if they do rise in response to the higher inflation it is destabilising?

His policy prescription is clear.

We should remain focused on completing the recovery, returning GDP to its pre-crisis trend, as the condition for achieving self-sustained inflation at our target in the medium term. To this end, we should keep using all of our instruments for as long as warranted, with the necessary flexibility to support the transmission of our policy stance throughout the euro area on its uncertain path out of the pandemic.

I can only assume that his “flexibility” would be for more interest-rate cuts and QE as we are reminded of his speeches on a Digital Euro allowing even more negative interest-rates.

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The drumbeat here has some extra notes to it today.

WIESBADEN – As reported by the Federal Statistical Office (Destatis), the index of import prices increased by 21.7% in October 2021 compared with the corresponding month of the preceding year. This has been the highest year-on-year change since January 1980 (+21.8%, on January 1979.

We can now pivot to this morning’s money supply figures and in particular to broad money.

The annual growth rate of the broad monetary aggregate M3 increased to 7.7% in October 2021 from 7.5% in September, averaging 7.7% in the three months up to October.

There was a particularly large growth of 120 billion Euros in October taking the total to just over 15.3 trillion and there are two ways of looking at this. Let me start with the one explained by Fabio.

The data suggest the current picture is dominated by a bout of “bad” inflation generated outside the euro area, whereas we are far from seeing abnormally large domestic demand.

You always know there is trouble ahead when someone blames foreigners.

First, 80% of headline inflation reflects shocks generated abroad, mainly because the euro area is a net importer of energy and commodities.

Actually the climate change policies the ECB now so fervently supports have made that worse. But the issue here is that in spite of all the extra money ( this month 120 billion) chasing a supply of goods an services restricted by supply shortages he feels able to claim this.

In fact, headline inflation exceeds domestically-generated inflation to an extent never seen before.

If we now switch to the reasoning I explained at the beginning of this crisis. Higher broad money supply leads to higher nominal GDP. We hope for economic growth but have to expect an inflationary phase too. Well allowing for the lags ( 18/24 months) that is where we are. But worse than that the likes of Fabio want to make the same mistake.

Oops, I did it again
I played with your heart, got lost in the game
Oh baby, baby
Oops, you think I’m in love
That I’m sent from above
I’m not that innocent ( Britney)

The Euro as a safe haven

The events of the last 24 hours have given the Euro a bid. At 1.128 versus the US Dollar it is up over 0.6% as we see a by now familiar pattern. Not as much as the Japanese Yen or the Swiss Franc but a move none the less. There may be a difference this time around in that the interest-rate rises hinted at elsewhere are looking rather less likely.

UK Interest Rate Futures Price 55% Chance Of 15 Bp Rate Hike By BoE In December Compared With About 75% Chance On Thursday – RTRS

Those with a wry sense of humour might like to note that it was only yesterday we looked at calls for the US Federal Reserve to taper its QE bond buying more quickly.

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In many ways the ECB resembles the SS Titanic as it steams full ahead towards the future. It’s real problem is an inability to change course as its former role as an enthusiastic inflation fighter gets dropped. Also it may manage to steam even faster should it bring in a digital Euro and cut interest-rates towards -3%. The problem here was unintentionally highlighted in the Fabio Panetta speech.

 in fact, the euro area is lagging behind the global recovery in demand. Services consumption remains well below its pre-crisis level; and durable goods consumption is showing nothing like the boom that is ongoing in the United States

So we ease again?

On the other hand, “bad inflation”, acting as a “tax” on demand, could ultimately move the economy further away from full capacity utilisation, depressing medium-term underlying inflation. This might require an easing of monetary policy.

The problem is that if we look back the Euro area economy was not doing well in spite of the things we are told are a stimulus. After all we have had mass QE and negative interest-rates for some years now. When will they actually work please? Or is it just a way of managing a decline?

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