Global Daily – ECB too optimistic on core inflation

by: Nick Kounis , Tom Kinmonth

Euro Macro: Core inflation to undershoot ECB forecasts – We continue to expect core inflation to undershoot the what is expected in the ECB’s Staff Macroeconomic projections. Indeed, we are actually somewhat downgrading our view of core inflation from the already weak profile we had earlier. This reflects signs that there is more slack in the labour market, which will keep wage growth depressed for longer. We expect eurozone core inflation to average 0.9% in 2017 and 1.1% in 2018. This compared to the staff forecasts of 1.1% and 1.4% for those years, respectively. The unemployment rate is still above estimates of the NAIRU and since 1999 wage inflation has only accelerated once it is comfortably below it. In addition, labour market reforms in a number of member states may mean the NAIRU is/will decline compared to current estimates. One sign of this is in Germany, where despite low unemployment, wage growth remains modest. Normally speaking, one would expect this weak inflation picture to trigger a further ECB QE extension well into 2018. However, we do not expect this. The ECB is running out of room to execute its QE programme given the current rules of the programme. In addition, economic growth is robust. (Nick Kounis)

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Euro Financials: After Spanish rescue the focus turns to the ailing Italian banks – Following on from the dramatic conclusion of Spanish lender Banco Popular two weeks ago, the focus on the banking markets now returns to the Italian banks. Banca Monte dei Paschi di Siena (BMPS) and the Venetian banks (Veneto Banca and Banca Popolare di Vicenza) are all in deep discussions with regulators as to the level that the state can provide assistance. The clear danger for the Italian banks is the enormous non-performing loan (NPL) portfolios. The situation is improving gradually, but there remains a huge amount to be done with gross NPLs still sit at roughly EUR 350bn (18% of total loans). Excluding an unforeseen ‘bad bank’ solution in Italy, it could take until the middle of the next decade to bring down NPL levels to European standards. The pressure to service these debts and increase provisions is severely impacting profitability. While the NPL issue depresses profitability, a tirade of other upcoming issues await the Italian banks. From an asset side there are both sovereign holdings issues and IFRS9 regulation that will negatively impact the narrative. Meanwhile, a number of assistance schemes will begin to run-down, such as the Atlante fund and TLTRO financing. Concurrently, European-led capital and funding requirements will begin to now ramp up for the Italian institutions. For me information please see Financials Watch – Italian banks to face a struggle to escape, for professional clients, see disclaimers in the document. (Tom Kinmonth)