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.
Inflation
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.
Comment
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?
Notayesmanseconomics's Blog 
How 24 hours can make such a difference !
The new African variant which could be harder to prevent through vaccine has knocked markets overnight and could be the end of monetary easing for some time to come. Here in the UK bets of an interest ratehike have been reduced from 75% to 55% overnight:
https://uk.investing.com/news/coronavirus/investors-cut-bets-on-boe-rate-hike-after-coronavirus-variant-news-2520238
LONDON (Reuters) – Investors scaled back their bets on the chance of a Bank of England interest rate hike in December in early trade on Friday after a coronavirus variant that might be harder to combat with vaccines was detected in South Africa.
Interest rate futures were pricing a roughly 55% chance of 15 basis-point rate hike by the BoE on Dec. 16 – after its next scheduled monetary policy meeting – compared with a roughly 75% chance on Thursday.
Yields on two-, five- and 10-year British government bonds fell by around 10 basis points in early trade.
On a day when stock markets are falling fast due to new covid mutation in Africa, BOE Pill decides to talk up hiking interest rates ! BOE members should be actors in a new version of Monty Python flying circus. If we face another lockdown I think there is far more chance of negative interest rates and the fact “Pill” makes no mention of these possibilities suggests to me he is only talking like this to boost sterling:
https://uk.investing.com/news/economy/bank-of-englands-pill-says-ground-is-prepared-for-rate-hike-2520467
LONDON (Reuters) – Bank of England chief economist Huw Pill said the way was clear for the British central bank to follow through on its plan to raise interest rates for the first time since the coronavirus pandemic hammered the world economy last year.
“In my view, the ground has now been prepared for policy action,” Pill said in the text of a speech to the Confederation of British Industry on Friday.
While avoiding any signal on the likelihood of the BoE increasing borrowing costs at its December meeting, Pill said recent economic data showed Britain’s economic recovery after its pandemic slump was continuing, supply chain problems were creating inflationary pressure and the labour market was tight.
That meant he supported the BoE’s steer earlier this month that rates would have to go up over “coming months”.
“In other words, given where we stand in terms of data and analysis, I view the likely direction of travel for monetary policy from here as pretty clear,” Pill said.
But he said there was still uncertainty about the economic picture and therefore the BoE could not give precise guarantees on what it will do with rates.
The BoE sent shockwaves through financial markets on Nov. 4 when it kept Bank Rate at its record low 0.1%. Investors had interpreted comments from Governor Andrew Bailey in late October as signalling that a November rate hike was on the way.
Pill, along with Bailey, was among the seven members of the BoE’s nine-strong Monetary Policy Committee who voted for no change on Bank Rate this month.
Crude oil futures down circa 13% on worry over covid varient !
Further lockdown after Christmas in UK is a possibility now. If that happens negative interest rates will be on the cards as well.
Hi Peter
There are a lot of fears about with the Yen surging 2 big figures to 113.20. That is always a sign as the fx markets make sure that if the Japanese do want to repatriate funds they will have to pay for it.
As to our man Pill he looks way out of his depth. From Reuters.
“What I’d like to do, which is a little bit patronising maybe to say, but which I’ll say anyway … is that we’re trying to train people to think the right way through policy,” he told an economics conference.
Who the hell does he think he is the BOE already has a governor and the members try and act as a whole.
His comments arent just patronising they show some arrogance.
Hello Shaun,
“bad inflation” , I had to laugh , very Orwellian. So whats good inflation – oh yes the plebs prices going up and nasty bad inflation is if the little miscreants try to get a pay rise.
Franly its begining to look like managing not a decline but a nose dive ……
bother! can’t they keep those plates spinning?
Forbin
Good inflation = my assets are going up.
Bad inflation = The plebs have too much money.
I don’t accept for a minute the interest rates are the best way to control inflation, raising/cutting taxes is far more effective, as is mass unemployment to curb inflation. Our self important masters of the universe would have us believe they can keep an economy in equilibrium with an 0.1% cut here or a 0.15% raise there.
I take the liberty of disputing this.
bill, I am on the same page with you here, raising taxes is a far better way of dealing with inflation and also a fairer way imo get the rich to fund our NHS.
Hello folks. I see some have down marked Peter’s comments, but I’m genuinely interested in why you have done so. Is it because of the ‘tax the rich’ bit (potentially responding to an established neo-classical economics narrative), or is it a more modern nod to the MMT argument that, whilst there is NO magic money tree, Goverments such as our own (who, let’s be honest, dictate the behaviour of central banks), can create large sums of digital money to pay for public services/infrastructure (we can’t go ‘bust’ being the call) as long as they account for it correctly, and drain potential inflationary monetary supply through taxation of the (correct) targeted groups, and not a machine gun fire extraction from all, potentially damaging the least well off disproportionately ? I’m genuinely interested if you’re of a mind to clarify; I do like much of MMT, but I’m not tribal vis-a-vis the different schools of economics.
Regards all, Iain
Hi Iain, this august forum is not the place to discuss MMT but no MMTer would ever suggest that taxes fund spending. My fellow inflation dove Peter got voted down for suggesting taxes go up without context. On the rare occasion I downvote anyone I always add a comment explaining why. We’re a jolly civilised bunch on here… Mostly!!
I think some dont like Peter’s religous stance , maybe, it doesnt bother me at all . this is a pretty civll site with a good input from commentators.
as far as MMT , well lets be careful as history tells us much and these are interesting times after all
we shall see
Thanks for your responses folks. Don’t see what’s wrong with discussing MMT on any economics forum Bill 😁.
I’m not typically interested by up/down ticks, but was genuinely interested in responses as Peter’s comments tended to flow naturally after Bill’s.
Anyway, a good weekend to all !
Iain
For the record, I did not mark this post down, it has nothing to do with religion.
I think the poster meant ethical/fairness the latter is what I meant however.
I think you can achieve a slowing down of the economy through taxation and if hyou are going tom use taxation the biggest pockets should face the biggest burden imo.
An interest rate rise can pnish the poor and could face someone losing their home.
Unfortunately, Peter, there are a lot of people out there who should not have been able to buy houses, but have, due to the distorted market.
Should we keep the market distorted, or even distort it further, so that these people can keep them, regardless of what it does to others’ well-being & home=owning chances?
Hi Shaun
Thankyou for your views on what seems
to be a perpetual rather than transitory
problem.
I think that your Titanic analogy could be
changed to a submerged submarine with
full ballast tanks and no compressed air
to resurface it!
AsPete Seeger wrote “When will they
ever learn.”
JRH
Hi JRH
Peter,Paul and Mary are a group I always associate with Leaving on a Jet Plane. As to the ECB if it was a submarine it would be one on a ledge with many talking of it resurfacing before it slips even deeper.
So, no interest rate rises until wages rise.
That sounds suspiciously like:
“We don’t want you to default on your home loans, but we certainly DO want you to pay as much as you can afford to the banks in perpetuity, & that means we’ll allow them to take every extra penny you earn in interest, forever, slaves.
And smile whilst yer about it.
As for savers, the upstart plebs think they’re entitled to more than the basics, do they? Get back in yer cages. WE’LL have that!
Hi therrawbuzzin
The only barrier to them taking interest-rates even more negative is that with a Digital Euro what will the banks do? The Precious will not have a role. Like savers it needs a positive rate of interest.
hmm , I wonder what other channels you and I watch