Wednesday, 1 February 2017

Inflation Rate at ECB Goal Doesn’t Mean Draghi’s Job Is Done

Mario Draghi still has reason to argue that it’s not yet job done when it comes to inflation.

Even with consumer-price growth accelerating to 1.8 percent -- a rate not recorded since early 2013 -- the European Central Bank president can insist that unprecedented stimulus is necessary to put the recovery on a more solid footing and stoke underlying price pressures that continue to be muted. But opposition to his view will probably get louder.

Amid a push by some German policy makers that it’s time to start at least considering how to exit from the ongoing stimulus program, Draghi’s response is set to focus on slowly declining unemployment, modest economic growth and the fact that reflation is largely being driven by energy prices. His pushback has also highlighted the risks that could derail expansion this year, including potentially disruptive elections, while underlying inflation remains weak.

“If growth and unemployment were to continue at this pace, then yes, it would create second round effects -- I just don’t think that’s going to be the case,” said Jennifer McKeown, chief European economist at Capital Economics in London. “Rising inflation is bad for consumers, we expect a decline in growth and it dampens consumer spending and real income growth. On top of that we have political uncertainty.”

A gloomy outlook stands in contrast to the across-the-board positive data Eurostat released on Tuesday: The economy grew 0.5 percent in the final three months of 2016, the fastest pace in three quarters, inflation is effectively in line with the ECB’s goal, and unemployment has fallen to the lowest since 2009.

Countering that positive news, core inflation remains below 1 percent, and Draghi repeated this month that risks to growth remain tilted to the downside, owing primarily to developments abroad.

Downside Risks

Protectionist policies pursued by the U.S. administration are threatening to weigh on exports, and concern about the U.K.’s strategy to exit the European Union is restraining confidence. With euro-skeptic parties gaining traction in opinion polls, elections in some of the region’s largest economies are also adding to uncertainty.

The euro rose in response to today’s reports and extended gains after the Financial Times published comments by a trade adviser to U.S. President Donald Trump, who said Germany is benefiting from a “grossly undervalued” currency. The euro traded at $1.0758 at 2:09 p.m. Frankfurt time.

Executive Board member Sabine Lautenschlaeger and Bundesbank President Jens Weidmann are arguing that the time may soon be ripe to start settling on an exit strategy. The ECB’s quantitative easing program is currently set to run until the end of 2017, and economists have predicted that the next shift in strategy won’t be announced before September. Some, however, are penciling in a start of tapering as early as this summer.

ECB Governing Council member Ewald Nowotny has urged for patience, saying a reduction in asset purchases won’t be discussed in March.

“We’ve been here before,” said Michael Schubert, an economist at Commerzbank AG in Frankfurt. “The link between employment and core inflation proves time and time again to be weak. Without core inflation, the ECB won’t move.”

Reference: Bloomberg Markets

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