Global Daily – Risks to the ECB’s inflation credibility

by: Aline Schuiling , Nick Kounis , Bill Diviney

Euro Macro: ECB watchers see somewhat higher probability of inflation undershoot – The results of the ECB’s Survey of Professional Forecasters (SPF) for 2019Q2 were published today. The participants to the SPF lowered their forecasts for growth and inflation in 2019 and 2020 compared to the previous survey. The new SPF forecasts are very close to the ECB’s own staff macroeconomic projections, which were published in March. The SFP participants now expect GDP to grow by 1.2% in 2019 and by 1.5% in 2020 (still above our own forecast of 0.8% and 1.3%, respectively), while the SPF forecasts for inflation now are 1.2% in 2019 and 1.4% in 2020 (also above our own forecasts of 1.2% in each of these years). The SPF also measures the expectations for inflation in the longer-term (2023). This is one of many indicators that the ECB uses in its assessment of whether inflation expectations are still in line with the ECB’s target of below-but-close to 2%. The SPF’s point forecast for inflation in 2023 remained stable at 1.8% in Q2. However, compared to 2018H2 (1.9%) the forecast has fallen somewhat. Moreover the probability distribution of the forecasts for inflation in 2023 shows that participants attach a somewhat lower probability of inflation being in a range of 0.0-0.5 pps around the target (probability from 58% in 2018H2 to 50% in 2019Q2) and that this decline had mainly shifted towards a higher probability of inflation being significantly below the target (from 28% to 34%).

The signs from the SPF are consistent with trends in market inflation expectations. The eurozone 5y5y inflation swap currently stands at 1.35%. This compares to average since 2104 of 1.7% and an average between 2005 and 2013 of 2.4%. It does seem that there is has been a structural downward shift. The ECB argues that this does not reflect a de-anchoring of inflation expectations, but rather a fall in the inflation risk premium, with investors now judging that an overshoot of the ECB’s price stability goal is less likely. However, the above survey evidence suggests that investors also see a greater probability of the ECB missing its target as well over the medium term. The time that ECB President Mario Draghi spent in yesterday’s press conference to emphasise the central bank’s commitment to meeting the goal suggests that it might be more concerned about inflation expectations than it is letting on. (Aline Schuiling & Nick Kounis)

US Macro: Muted inflation is not just because of distortions – Core inflation surprised to the downside in March at 0.1% mom, below our and consensus forecasts of a 0.2% gain (unrounded, the miss was less dramatic, at 0.148%). Much is being made of the drag from apparel, which fell 2.0% mom on the back of a methodological change to data collection – indeed, absent this drag, inflation would have been in line with estimates. However, we see muted inflationary pressure across the board in recent months. For instance, the increased approval of generics is weighing heavily on drugs prices, which are now falling on a sustained basis for the first time since the CPI series was established in 1950. Transportation services are an even bigger drag, subtracting 0.2pp from yoy inflation compared with 2018, driven by an easing in car insurance premium hikes. More importantly for the outlook, core services inflation (i.e. excluding shelter and medical) remains remarkably stable at c.2% yoy, despite labour market tightness putting upward pressure on wage growth. With productivity growth and profit margins relatively high, we think there is room for a further pickup in wage growth without accompanying cost-push inflation. This should keep the Fed comfortable with its current on-hold policy stance. We continue to expect no change to rates on our forecast horizon to end-2020. (Bill Diviney)