Macro Weekly – Getting a little closer to the ECB’s target

by: Han de Jong

  • Eurozone key confidence indicators continue to strengthen
  • Preliminary eurozone April inflation data shows some pick up in inflation
  • Trump tax plans still in infancy stage
  • US Q1 GDP growth undershoots modest expectations
Macro-Weekly-1-May-2017.pdf (137 KB)

Things are moving nicely in the eurozone. Confidence data has been on a rising trend since the middle of 2016. Typically, these sort of indicators do not rise endlessly. Given the levels they have recently reached, one should expect them to consolidate or drop back somewhat. However, the most important ones of these indices rose again. Germany’s authoritative Ifo index of business confidence, for example, rose to 112.9 in April, its third consecutive monthly rise, up from 112.4 in March. This index briefly exceeded its April level in 2010 and in 2006/07.

The broader European Commission index of ‘Economic Sentiment’ for the eurozone rose from 108.0 in March to 109.6 in April, having more or less been stable for three consecutive months. This indicator was only higher than its current level briefly in 2007 and before that in 2001.

Eurozone monetary developments are also positive

Data on monetary developments in the eurozone were also positive. M3 growth accelerated to 5.3% yoy in March, up from 4.7% in February. M1 growth accelerated to 9.1%  from 8.4%. Credit growth also strengthened. Credit growth to households amounted to 2.4% yoy in March, against 2.3% in February, credit to non-financial corporates was 2.3% up yoy, versus +1.9% a month earlier.

Inflation bounces back, but this is temporary

The flash estimate for inflation showed a bounce in the eurozone’s HICP in April. Headline inflation stood at 1.9% yoy, up from 1.5% in March (though it stood at 2.0% yoy in February). Core inflation rose to 1.2%, up from 0.7% in March and the highest level since  2013.

So at first sight, there is every reason for the ECB to be happy. Economic growth is above trend and looks to continue while the ECB’s inflation target, inflation below, but close to 2%, is currently being achieved. There are a couple of ‘buts’ to make, however.

The April inflation data more than likely overstates the actual underlying pressures. Services inflation stood at 1.8% per annum, up sharply from 1.0% in March and the highest since 2013. This probably reflects the timing of Easter and the prices of package holidays. One must assume that the inflation numbers will fall in the months ahead due to base effects, only to rise a little towards the end of the year and in 2018.

ECB to change its tone in June, but a bigger dilemma is looming in 2018

At his press conference following the Governing Council’s policy meeting ECB President Mario Draghi indicated that the risks to the eurozone economy have become more balanced recently. It was not sufficient to end the ECB’s easing bias, however. But we expect that easing bias to be ended in June as a first step by the ECB to head to the exit of its QE policy. The next step will be the announcement of tapering, which we expect to be made in September to prepare markets for this process in January 2018.

My personal view on inflation is that the global output gap and technology will keep a lid on it, also in economies with shrinking or already small output gaps. Sure, inflation is likely to rise somewhat in key economies, but fears for runaway inflation are completely overdone in my view. If I am right, this may pose a significant challenge to the ECB next year. Inflation may still be below target next year even as the economy continues to grow at an above-trend pace. The threat of deflation due to a lack of demand during a period of weak economic growth has to be taken seriously. But when growth is relatively solid and low inflation is mainly driven technological process, it is a different matter. Any deflation in such an environment could be labelled ‘good deflation’ and does not provide justification for sustained aggressive accommodative monetary policy, in my view.

Weaker confidence data in China, mixed in the US

I have argued for a while that the acceleration of growth in China is an important driver of increased growth momentum globally. This acceleration in China has been visible in Chinese trade data and, for that matter, in the data of China’s most important trade partners. It has also been visible in business confidence indicators in China and, last but not least, in a small rise in China’s Q1 GDP growth number. However, we also know that Chinese stated policy is to address financial-stability risks and control leverage. Modestly restrictive policies have been implemented and the question is when they will affect activity and to what degree. The PMIs for April provide a first view. The national manufacturing PMI eased more than expected, falling from 51.8 in March to 51.2, its lowest level since October last year. The drop in the services sector PMI was even greater, falling from 55.1 to 54.0, its lowest level since September. These data can be volatile and we must remember that March was a very strong month. Nevertheless, it could be a sign that Q1 was a growth peak in China. If Chinese growth slows that would pose a challenge to the global economy, although there seems to be sufficient momentum, at least for now.

While confidence data in the eurozone continue their upward trajectory and Chinese confidence appears to have eased in April, evidence from the US is mixed. Regional business confidence indicators from Dallas and Richmond eased modestly in April, but are still at historically very high levels. Business confidence in the Kansas area dropped sharply in April from a very high level in March. On the other hand, the more authoritative Chicago PMI rose modestly in April to reach its highest level since late 2014.

Trump’s tax plans underwhelm

US President Trump’s most recent proposal on taxes did not really add up to much. Sure, the intention is to cut personal and business taxed significantly, but given the lack of funding, it is difficult to take a strong view on what, when and how tax changes will be implemented. This is a disappointment, but is perhaps compensated for by stronger momentum of the global economy.

US GDP growth disappoints, once again

US Q1 GDP growth amounted to a mere 0.7% qoq annualised, which was a touch below expectations. The poor growth number is not reflective of the underlying strength of the US business cycle. Statistical problems with the seasonal adjustment factors most likely depressed the number.  Private consumption grew at a pace of 0.3%, the lowest in a long time. On the positive side, business investment grew strongly as fixed investment advanced at an annualised pace of 10.4%. This was largely, but not entirely, accounted for by investment in the energy sector as the rise of oil prices since the trough early 2016 is now boosting investment again in the sector. This is all in line with developments of durable goods orders and shipments. Durable goods orders rose 0.7% mom in March, following a 2.3% mom rise in February. Non-defence, ex-air capital goods shipments rose 0.4% mom, following an upwardly revised +1.1% in February. These shipments rose at an annualised pace of some 7.5% qoq in Q1, suggesting that corporate investment pending is, indeed, picking up. Corporate earnings numbers have been strong so far during the Q1 earnings season, which may also suggest that investment spending will continue to strengthen in the quarters ahead.

Inventories: a serious, but temporary drag

Inventories increased more modestly than in the previous quarter, leading to a negative growth contribution of no less than 0.9% of GDP. This is likely to be a blip and inventories should make a material contribution to GDP growth in the quarters ahead.

All in all, economic data has been encouraging globally and we see no reason to change our positive view on the global outlook. But the easing of Chinese business confidence is something that needs watching.