- Eurozone inflation surprisingly stable in February despite widespread falls in country data…
- …we expect inflation to fall further in the coming months
- ECB to keep rates on hold this week, but likely to end sterilisation of SMP programme
- Any weather related weakness in this Friday’s labour market report unlikely to affect Fed tapering path
Eurozone inflation in February does not stack up – further downside seen in coming months
Eurozone inflation was surprisingly steady at 0.8% in February. The consensus forecast was for a decline to 0.7%, while we were expecting a fall down to 0.6%. The outcome is rather odd as it does not seem to be consistent with the falls in annual inflation we have seen in Germany (-0.2 percentage points), Spain (-0.3 percentage points), Italy and Belgium (-0.1 percentage points in each case). The outcome may have been driven by a jump in inflation in France, where the data are not yet released, but this would be difficult to explain. We suspect that eurozone inflation will be revised down in the final estimate. The components of the eurozone data showed core inflation rose to 1% from 0.8%, driven by a jump in goods price inflation, which is again difficult to explain in an environment of weak global manufactured goods prices, subdued commodity prices, and euro strength, which have led to falls in import prices. The rise in the core offset significant falls in food and energy price inflation. Looking forward, we continue to expect inflation to fall further in the coming months, reflecting the slack in the economy, falling import prices and further downside for retail food price inflation.
ECB likely to keep rates on hold this week but stop SMP sterilisation and keep door open for more action
The higher than expected inflation numbers reduce the chances of an ECB rate cut, and as such we saw sharply higher eurozone government bond yields on Friday and a stronger euro. We maintain the view that on balance the central bank will keep rates on hold at this week’s meeting. A number of Governing Council members have suggested that they are yet sold on the idea of a negative deposit rate and it would seem therefore that inflation trends would need to be weaker still to trigger this move. However, we do still think that stopping SMP sterilisation by ending the absorption tender is likely. Excess liquidity has continued to fall (see chart) and ending the tender could be a strong signal that the ECB is determined to maintain an accommodative monetary stance for the foreseeable future. We also expect the ECB to keep the door open to a rate cut in subsequent meetings, which could still materialise given the likelihood that inflation will resume its downward trend.
Cold weather may affect February’s nonfarm payrolls once more …
This week will be a bumper week in terms of US data, but financial markets will mostly focus on Friday’s nonfarm payrolls report, as it will be the most important piece of data before the Fed’s March meeting. Judging from the initial jobless claims series, the labour market recovery has kept its momentum. Still, we fear that the report, once more, will be affected by cold winter weather. That is why we are forecasting a relatively modest 150K gain in payrolls, though we will keep a close eye on this week’s ISM’s and the ADP figures to get a better grip of the strength of the labour market.
…but Fed set to keep trimming its asset purchases
Although weather-related weakness in payrolls is likely to affect markets, we doubt that it would have an impact on the Fed’s tapering policy. Indeed, during her Testimony before the Senate Banking Committee last week, Fed Chair Yellen said that the Fed needed to get ‘a firmer handle’ on how much of the softer data can be explained by weather and what portion if any is due to a softer economic outlook, suggesting that the Fed is not convinced that the outlook has deteriorated and is set to continue tapering its asset purchases. Meanwhile, we do think that another drop in the unemployment rate to 6.5% will make it increasingly likely that the Fed will embrace a form of qualitative forward guidance, focusing on a range of labour market variables rather than just the unemployment rate.