The European Central Bank has spent most of the credit crunch era between a rock and a hard place. If anything the rocks are getting tougher and the hard place harder. This was supposed to be the year of recovery for the Euro area with economic growth expected of 1.4% to be followed by better years. Instead the latest Eurostat GDP (Gross Domestic Product) estimate was for annual growth of 0.8% and quarterly growth of 0.2%. In the larger scheme of things that is not such an enormous divergence but there are two additional factors at play. Firstly whilst Spain has been a bright spot, Germany is showing signs of struggling, France is relying on government spending to show slow economic growth and Italy has remained well Italy. So the sunny uplands of 2015 suddenly do not look quite so sunny. Secondly the Euro area is beginning to establish a trend of weak nascent economic growth at best.
What about inflation?
This is something of a rod that the ECB has created for its own back. Let me explain why. The situation was illustrated by the valedictory speech of the previous ECB President Jean-Claude Trichet.
And, as I just said, over the first twelve years we have delivered average yearly inflation at the level of less than 2%: it is a better result than the previous national currencies over the last 50 years, including the Deutsche Mark. Here in Aachen, I can say, the promise “stark wie die Mark” has been fully respected.
In the version I watched he defined the performance as 1.97% in the manner of someone giving themselves 10/10! In itself this may not have created such a problem as for example inflation targeting does impose a discipline on central banks something sorely missing right now elsewhere. But 2014 has seen a catch in this and that is the way that the ECB has made mistakes in its presentation of this.
Firstly the ECB has consistently underestimated the scale of disinflationary pressure in 2014. This was highlighted again at last weeks press conference and the emphasis is mine.
at the time the December 2014 Eurosystem staff macroeconomic projections for the euro area were finalised, annual HICP inflation was foreseen to reach 0.5% in 2014, 0.7% in 2015 and 1.3% in 2016. In comparison with the September 2014 ECB staff macroeconomic projections, they have been revised significantly downwards.
This is just one example of how the ECB has ended up like a dog chasing its tail on this subject but dogs tire of this game whereas the ECB continues to go round and round. This to my mind has been driven by the fly in the ointment which is this.
Monetary policy is focused on maintaining price stability over the medium term
You see this is an outright lie as it is set at inflation stability at 2% per annum whereas pure price stability would be unchanged prices. This is a common central bank Jedi Mind Trick but as both consumer inflation and inflation expectations have fallen in the Euro area in 2014 the ECB has sunk into a quagmire partly of its own making. As of last Thursday it continued to do so.
All of our monetary policy measures are geared towards underpinning the firm anchoring of medium to long-term inflation expectations, in line with our aim of achieving inflation rates below, but close to, 2%, and contribute to a return of inflation rates towards that level.
Hands up anybody who believes that inflationary expectations are underpinned in the Euro area right now? No I did not think so….
What about the oil price fall?
This is a good news story for the Euro area as I discussed on the 28th of November . It will have a reflationary impact on the various economies there and one effect is already being felt according to Mario Draghi.
Just to give you a very rough estimate, our import bill of energy, of oil, fell about €10 billion between the second and the fourth quarter of this year. Now, that is about 0.2% of nominal GDP in that period. That is not going to be the final impact, because Europe also exports oil, but the net is unambiguously positive.
If we skip the troubling thought that this may have been the growth measured by Eurostat which otherwise would have been zero on a quarterly basis we see that going forwards there will be other positive impacts too. We also know that as I type this the situation is still developing as the price of a barrel of Brent Crude Oil has continued to fall (warning oil prices can plummet as well as fall…..) and is now just above US $66. So at this stage of the saga we have an improvement in growth prospects and we can remind ourselves of a past US television series.
Sunday, Monday, Happy Days,
Tuesday, Wednesday, Happy Days,
Thursday, Friday, Happy Days,
Saturday, what a day,
Groovin’ all week with you.
Back to inflation
The catch is that the ECB has continually promised to return inflation to its target and the fall in oil prices will push it below a significant barrier if they stay here. If we return to the ECB press conference last Thursday we were told this.
We estimate the direct and indirect effects on HICP inflation are going to be 0.4% in 2015 and 0.1% in 2016. That is very important to keep in mind because it could alter the profile of inflation rates over the coming months, especially in the next few months.
Could?! If we factor in the fact that oil prices have continued to fall since then by around US $4 then a 0% consumer inflation print is marching over the horizon. Indeed we may have negative consumer inflation to set against negative interest -rates.
ECB policy moves
We have had a torrent of open mouth operations as highlighted here.
Taken together, our measures will have a sizeable impact on our balance sheet, which is intended to move towards the dimensions it had at the beginning of 2012.
This is the trillion Euro promise which keeps echoing around the walls of the ECB’s shiny new building. However this week has seen yet more evidence of a different reality.
Covered bonds and ABS cumulatively purchased and settled as at 05/12/2014: 20,927 million and 601 million respectively.
After all the hyperbole from Mario Draghi about ABS (Asset Backed Securities) purchases the first week’s effort of 368 million Euros was paltry. Well it is now hard to know whether to laugh or cry at the subsequent 233 million Euros. After all when did central banks return to counting in millions?
To QE or not to QE?
By this I mean purchases of sovereign bonds as the threshold for private-sector bonds went a long time ago when the ECB first purchased covered bonds in July 2009. There are a myriad of problems here before we even get to the issue of whether Mario Draghi can get a majority vote in favour?
Firstly as the record of QE (Quantitative Easing) is patchy at best will it work? Even worse the part which seems to have given a push to the United States was most similar to the covered bond programme which the ECB has already tried twice. Third time lucky?
Next we have the issue of the programme being backed by 18 (soon to be 19) national treasuries rather than a single one. Just at a time when places such as Italy are seeing an increasing number of voices calling for a Euro exit. What could go wrong?
Then we have the issue of bond yields being so low anyway with even the laggard in this area that is Portugal having a ten-year benchmark yield of 2.81%. On that road the benefits of sovereign QE are already being experienced as we see that the Frenchman in the film the Matrix Revolutions did not understand “Cause and Effect” as well as he thought he did.
On today’s journey we see that the trillion Euro promise has got no nearer to being fulfilled. It could be something of a mythical beast in the same way that Mario Draghi promised Outright Monetary Transactions but never used them. OMTs have been hailed by hedge funds and it is true that hedge funds made a lot of money out of the promise. But the real economy has been quite a different matter as I would not be writing this article if it had also responded. So we could be seeing another central banking Jedi Mind Trick.
If you wish for a glass half-full then they are doing this because the oil stimulus will add to the existing monetary stimulus and provide an uptick in economic growth as we move into 2015. The dark side fears are that the oil price fall is associated with a weakening level of demand so that we will have dropped before we grow again.
Maybe the TLTRO (Targeted Long=Term Refinancing Operation) on Thursday will help but the last one disappointed and all I see on my Twitter timeline are lower and lower estimated impacts for this one. The falling value of the Euro has made a far bigger impact on the situation and that of course has mostly been the mirror image of US Dollar strength.
As I look at the state of English cricket right now I wonder if it is the acronym ECB which is part of the problem!