Global Daily – ECB casts doubt on its reaction function to trade wars

by: Nick Kounis , Aline Schuiling , Bill Diviney

ECB View: Governing Council sees impact of trade war on inflation as ‘ambiguous’ – The account of the ECB’s June Governing Council meeting did not add a lot of new information compared to the press conference following the policy decisions. However, there was an interesting discussion about the impact on inflation of a possible escalation of trade wars. The account notes that ‘concerns were expressed about the possibility that such tensions could lead to a more general decline in confidence throughout the global economy, beyond any direct effects from the imposition of tariffs. Against this background, the balance of risks to the global economic expansion continued to be assessed as tilted to the downside’. However, ‘the impact of increased trade protectionism on inflation was seen as being more ambiguous and uncertain. On the one hand, higher tariffs and trade barriers should have a direct upward impact on the prices of the goods affected and along global supply chains. On the other hand, there were also indirect effects from protectionism through lower exports and diminished confidence, which implied weaker demand and lower prices’. The ECB’s uncertainty about the net impact on inflation of a trade war casts some doubt on its reaction function in the case of a sharper escalation in protectionism. In our view, as long as inflation expectations remained anchored, the ECB would likely easy monetary policy in case of a full-blown trade war. However, the possible inflationary impact might mean it would not move as quickly to provide stimulus as would be the case in a typical economic shock. (Nick Kounis)

Euro Macro: House prices sharply higher– Eurostat has published its report on house prices in the eurozone earlier this week. It shows that house prices continued to rise sharply in the first quarter of this year. The eurozone aggregate harmonised house price index rose by 4.5% yoy in Q1, up from 4.3% in Q4 and 3.8% in 2017Q1. Prices have increased non-stop on a qoq basis since the start of 2015, although the data are non-seasonally adjusted and therefore volatile. The eurozone housing market is supported by a number of factors. In the first place, the interest rate on mortgages has dropped in recent years on the back of the expansionary policy measures of the ECB. The composite interest rate on mortgage loans, as calculated by the ECB, has gradually fallen from around 4% at the start of 2012 to 1.8% in May 2018. Moreover, banks have eased their lending standards on mortgage loans during almost every quarter since the start of 2014. Another factor supporting the housing market is the ongoing improvement in labour market conditions. Employment has grown non-stop on a quarterly basis since the middle of 2013, while the unemployment rate has fallen from above 12% around the middle of 2013 to 8.4% in May 2018. Looking forward, we expect the factors that have supported house prices in the past few years to remain supportive throughout this year. (Aline Schuiling)

US Macro: Trade war unlikely to have a big impact on US inflation – Core inflation in June printed in line with expectations at 0.2% mom, or 2.3% yoy (up from 2.2% in May). A cooling in shelter inflation, which rose just 0.1% mom, was offset by strength in medical services (+0.5% mom), and a partial unwinding of earlier weakness in used cars (+0.7% mom). Core inflation has recovered considerably over the past six months, but we continue to see little sign of labour market tightness exerting upward pressure on core services inflation, and nor do we expect it to in the near term. As such, while it gives the Fed greater confidence to continue gradual rate hikes, the firming in inflation is unlikely to spur more aggressive tightening. The prospect of a more broad-based implementation of import tariffs poses some upside risks to core goods inflation, but this component makes up a relatively small weighting in the core CPI and PCE baskets at c.20% (the remainder being housing, medical, and other services). Meanwhile, the proposed tariff rate on $200-400bn of imports from China is relatively modest, at just 10%, with much of this likely to be offset by currency moves (the USD has appreciated 6.5% vs the CNY in recent months). (Bill Diviney)