- Eurozone inflation fell to 0.5% in March, as the core reversed its rise in February…
- …but ECB is sounding tolerant of low inflation and could sit on its hands this week
- Fed Chair Yellen strikes dovish tone, but does not go back on ‘six months’ message
Eurozone inflation further below ECB’s goal…
Eurozone inflation fell to 0.5% in March from 0.7% in February, according to the flash estimate. This was in line with our own expectation but below the consensus forecast of 0.6%. It was driven by a fall in core inflation to 0.8% from 1%, which takes it back to January’s level. It suggests the rise in core inflation in February was likely a blip and not a sign that disinflationary pressures are starting to fade. Meanwhile, food price inflation fell sharply (to 1% from 1.5%), though this was partly offset by a slight rise in energy price inflation (-2.1% from -2.3%). We think that inflation will continue to surprise the ECB on the downside in the coming months, given that slack will continue to curb inflationary pressures, while commodity prices are subdued, global manufactured goods prices are falling and the euro is strong. This will keep the possibility of further monetary policy easing very much alive in coming months.
…but Mario could shrug his shoulders again this week
Nevertheless, the central bank has shown quite some tolerance for low inflation recently. It is already forecasting below target inflation through 2016, but still left policy unchanged in March, despite this. The message seems to be that the euro would need to surge much further (north of 1.42 in our view) or the recovery would need to falter to trigger further policy easing. With the euro below 1.40 and most evidence suggesting that the slow economic recovery will continue, it seems unlikely to us that the ECB will ease policy this week. Mr. Weidmann’s readiness to consider QE seems to be as an option in a much more negative scenario than the current one. Although deflation is not our main scenario, if there were to be a new shock, the economy would be very vulnerable given the low starting point for inflation and the elevated level of slack. We therefore think it would be wise for the ECB to fight against deflationary risks by taking pre-emptive policy action this week. However, this does not seem likely following the inaction seen at the March meeting. The bottom line is that more talk and no action from President Draghi could disappoint investor speculation once again this week.
Fed Chair Yellen: considerable slack remains
During a speech at the National Interagency Community Reinvestment Conference in Chicago, Chair Janet Yellen stated that there remained considerable amount of slack in the economy and labour market. As such, extraordinary accommodative monetary policy was still needed and will be ‘for some time’. The arguments that the Chairwoman presented were not new, but overall the speech had a dovish tone. According to Chair Yellen, there remains a considerable amount of slack in the economy because 7 million people were working part-time, but would like a full-time job. Meanwhile, although firms were firing fewer people, they remained reluctant to increase the pace of hiring, while workers were afraid to voluntarily quit their job. Yellen also argued that long-term unemployed had similar characteristics as short-term unemployed, while she saw part in the drop of the participation rate as cyclical, and said that wage growth has remained low by historical standards. Overall, it seems that Chair Yellen has tried to make her message a little more balanced, following the hawkish FOMC press conference last month. However, she did not explicitly pull back from the message that interest rates could go up around six months after the Fed’s quantitative easing programmes end (likely this October). As a result, implied rates on futures and the short end of the Treasury curve fell only slightly following the Yellen speech, with most of the rise following the FOMC remaining in place.