Global Daily – Core inflation will disappoint ECB forecasts (again…)

by: Aline Schuiling , Bill Diviney

Euro Macro: Core inflation to remain stuck at around 1% throughout this year – Eurostat published the final estimate for eurozone inflation in December 2018 today. The data were unrevised from the flash estimate, with headline inflation declining to 1.6% in December, down from 1.9% in November. The details of the report show that this decline was totally due to a drop in energy price inflation (from 9.1% to 5.4%). Core inflation (excluding food, energy, alcohol and tobacco) stabilised at 1.0%, the level it has been hovering around since the start of 2017. Looking forward, we think that core inflation will remain stuck to around this level throughout 2019. Indeed, the eurozone economy has slowed down significantly in the second half of 2018, to levels well below trend growth, while recent indicators have suggested that growth will remain subdued in the first quarter of 2019. Thereafter, we expect growth to pick up somewhat again as the factors that have temporarily weighed on growth in Germany and France in the final months of 2018 and first months of 2019 (i.e. disruptions in car production and car sales due to the introduction of new emission standards and strikes and street protest, respectively) will unwind. However, we think that growth will not rise above the trend growth rate after 2019Q1 but will remain close to the trend. As there currently still is slack in the eurozone labour market according to the broader U6 indicator, and the economic outlook suggests that this will persist, we expect wage growth to decline in the course of this year. Indeed, we think the recent pick up in wage growth was merely compensation for the fact that real wage growth unexpectedly dropped to below zero in the first half of 2017 as energy price inflation jumped higher. All in all, inflationary pressures stemming from the labour market should remain subdued this year. On top of that, the slowdown in global growth and world trade suggests that eurozone core-goods price inflation will also remain subdued. All in all, we expect core inflation to be 1.1% on average this year (the same rate as in 2018) and headline inflation to be 1.0% as well. These forecasts are well below the most recent projections by the ECB of 1.4% for core inflation and 1.6% for the headline rate. (Aline Schuiling)

Fed View: Balance sheet is becoming a bigger talking point on the FOMC – The metamorphosis of Fed hawks into doves has continued, with the latest example being Kansas Fed president George. Alongside Cleveland Fed president Mester, she had been one of the most hawkish members of the Committee until recently, but in remarks on Tuesday she joined the chorus of officials calling for a pause in rate hikes.

Her most interesting comments came in a subsequent interview with the Wall Street Journal, and concerned the balance sheet unwind that the Fed started in October 2017. She said that she ‘didn’t really embrace […] this idea that it was like paint drying’. Indeed, she said that one the reasons she opposed the last round of QE was the uncertainty over whether the ‘benefit outweighs the cost’ of the policy, given that it was not an emergency situation. As such, there is also uncertainty about the effect of the unwind, and she said that it could be a ‘fair explanation’ for some of the recent market volatility. She added that if ‘it became clear that this was having a particular effect that we can identify, or we have some level of confidence in, I think of course it would be fair game’ to discuss altering the policy. The comments went somewhat further than a blog posting from Atlanta Fed president Bostic – a dove – where he said that ‘it is far from clear that the ongoing reduction in the balance sheet is having an outsized impact on the stance of monetary policy’, albeit that ‘nothing is written in stone’ regarding the policy.

Taken together, we think that the bar would still be rather high for the Fed to shift course on the balance sheet, and that it would take a more sustained period of market volatility than we saw at the end of 2018 to push the Fed to make adjustments. Nonetheless, the commentary shows that the topic is getting much more attention than it had until recently. (Bill Diviney)