- Eurozone headline inflation likely to move up in coming months; core likely to rise gradually during 2016…
- …but process not going fast enough for ECB, hence forceful December monetary stimulus package on the cards
- As expected, IMF formally approves China RMB inclusion in the SDR
Eurozone inflation looks set to start moving higher
Early inflation data for November from Germany, Spain, Italy and Belgium provided some insights into the eurozone total, to be published tomorrow. The overall signal is that inflation probably edged up last month, to 0.2% yoy from 0.1% yoy in October. Oil prices fell sharply in the latter part of last year, and that effect is starting to ‘fall out’ of the inflation numbers. The gap between headline inflation and core inflation (recorded at 1.1% yoy in October) should narrow. Indeed, headline inflation will probably rise more sharply over the next couple of months (we estimate 0.5% yoy in December and 0.8% yoy in January).
ECB still needs to ease
The upcoming rise in headline inflation has prompted the question in some quarters whether the ECB needs to step up monetary stimulus this week. We think it does. Headline inflation would still be well below the price stability goal of close-to-but-below 2%. In addition, on our estimates the uptrend in headline inflation will lose momentum after January, as base effects related to oil have a less positive effect. In addition, to get a sustained rise in headline inflation, we need to see a convincing uptrend in core inflation.
Lower euro and stronger economy needed
Core inflation looks to have bottomed out, helped by a rise in core goods price inflation. This was driven by the upswing in import price inflation (ex-energy) – see chart. However, core import price inflation has turned lower recently reflecting that the euro’s depreciation started to run out of steam earlier in the year. So a renewed fall in the euro is important to get import prices rising again and this has already started to happen as markets have anticipated further action by the ECB. More fundamentally, economic growth needs to remain above trend so that domestic inflation pressures start to build. However this process will take time.
The ECB’s December package
We think that the ECB will announce a broad package of measures. A 20bp cut in its deposit rate taking it to -0.4% looks to be on the cards. We also expect the ECB to increase the size of its QE programme, with monthly purchases increased by EUR 20bn per month, taking the total to EUR 80bn. The programme could eventually total EUR 1.8 trillion, while an increase in the eligible universe to include regional bonds is likely. The forward guidance will also likely be strong. Asset purchases will no longer end in September 2016, but will continue as long as necessary. Meanwhile, the ECB will probably communicate that the deposit rate could be cut further if necessary.
IMF formally approves RMB inclusion in the SDR basket, …
Meanwhile, yesterday the IMF decided to include the Chinese renminbi (RMB) into the currency basket of the Fund’s Special Drawing Rights (SDR), an international reserve asset created in 1969. This will further contribute to the internationalisation of the Chinese renminbi, a goal of high priority to China’s policy makers. The RMB’s share in the revised composition of the SDR basket will be 10.92%. The shares for the currencies that were already in the basket will be revised to 41.73% (from 41.9%) for the US dollar, 30.93% (from 37.4%) for the euro, 8.09% (from 11.3%) for the British pound and 8.33% (from 9.4%) for the Japanese yen. The new SDR basket will become operational on 1 October 2016, to give SDR users time to adjust to the new composition.
… a move that was widely expected
The move was widely expected. The IMF staff had already given a positive assessment of CNY inclusion several weeks ago. This assessment concluded that the RMB does not only continue to meet the export criterion for inclusion in the SDR, but also the other criterion of being a “freely usable” currency. Freely usable is being defined as being widely used for international transactions and widely traded in the principal foreign exchange markets. Staff had also concluded that the Chinese authorities had taken the necessary steps to address remaining operational issues, identified in an earlier staff assessment made in July 2015. These included the opening of onshore bond and currency markets to foreign central banks in addition to previous measures directed at gradually liberalising the capital account and the exchange rate regime and increasing opportunities to hedge RMB exposures. Furthermore, other key stakeholders represented in the IMF Board, including the United States, had already indicated to back RMB inclusion in the SDR basket.
We expect mild depreciation of the Chinese currency versus US dollar in 2016
Over the coming year, we expect the Chinese authorities to maintain their current policy of allowing a gradual currency depreciation to support exports and re-inflate the economy. We also expect the PBoC to reduce volatility in the yuan and narrow large discrepancies between the onshore and offshore yuan. In our view, the effect on additional demand from central banks for the yuan as a reserve currency will be limited (the SDR quota represent less than 3% of total global FX reserves) and the role of the renminbi as a reserve currency will rise only gradually. We expect the renminbi to weaken versus the US dollar next year, reaching 6.55 by year-end. We expect a moderate recovery in 2017 (to 6.50 e.o.p).