Global Daily – The coming disinflation

by: Nick Kounis , Aline Schuiling , Joost Beaumont

Euro Macro: Headline inflation will turn negative, core inflation to gradually decline – While there is a broad consensus that the eurozone and global economy have entered a deep recession, there has been more debate recently about the consequences for the inflation outlook. It has been argued by some commentators that we are facing a supply shock (which means lower output, but higher prices) coupled by an unprecedented scale of monetary and fiscal stimulus, which will lead to a surge in inflation. We fundamentally disagree with this view point. The hit to the global economy in this crisis looks to reflect a combination of demand (lower output and prices) and supply shock. However, it seems likely to us that the demand shock is actually dwarfing the supply shock at this stage. The key driver of the downward revisions to our growth forecasts has been the likelihood of sharp falls in discretionary consumer spending. In addition, there will be a second round demand shock from tightening financial conditions, rising unemployment and corporate defaults. The macro stimulus measures that we are seeing are likely to only partially offset this shock to demand, and we judge that spare capacity will build in coming quarters, which will bear down on underlying inflationary pressures. As well as these more medium-term downward pressures, the collapse in oil prices will be an immediate drag on inflation.

We present our updated inflation forecast in the chart below. In the near term, inflation is likely to fall sharply due to the correction in oil prices. Indeed, we already see signs of this in the early March inflation data (see below). In the second quarter, we think HICP inflation will register negative numbers on a year-over-year basis. Assuming some recovery in oil prices later in the year, headline inflation should bounce back sharply towards 2% by mid-2021. However, beyond that, headline inflation will fall again to converge towards core inflation. Core inflation is likely to slow significantly in coming quarters. Given the weakness in demand, we expect core inflation to fall to just 0.6% by the end of next year from around 1.2% now. As a comparison, core inflation fell by around a percentage point following the global financial crisis. (Nick Kounis)

Eurozone inflation drops in March – A number of individual eurozone countries published inflation data for March today. Germany reported a drop in harmonized inflation to 1.3%, down from 1.7% in February, Spain a drop to 0.2% from 0.9% and Belgium (non-harmonized) to 0.6% from 1.1%. Details of the inflation numbers are still scarce, but the components that have been published so far, as well as the written statements by the statistical offices, all suggest that the drop in oil prices since the start of March was the main downward factor. On top of that, the detailed reports from the main German states show that package holidays had a downward impact on inflation as well. Still, it seems that this is mainly due to the normal volatility in this series. Indeed, package holidays had an upward impact on inflation in February, and the decline in March falls well within the range of monthly volatility that we have seen in the February-March period in the past few years. Also noteworthy is that Belgium’s statistical bureau explicitly mentions that the impact of the outbreak Covid-19 does not yet show up in its inflation numbers as the index was largely measured before the measures aimed at limiting the spreading of the virus became effective. On Tuesday 31 March, the flash estimate for eurozone inflation will be published. We expect core inflation to decline to 1.1% in March, down from 1.2% in February, and the headline rate to fall to 0.7% from 1.2%. (Aline Schuiling)

Euro Fixed Income: Eurosystem ramped up asset purchases in fight against tightening financial conditions – The weekly figures of the Eurosystem’s net asset purchases showed that the central bank bought EUR23.6bn of bonds last week under its regular Asset Purchase Programme (APP) and the extra EUR 120bn envelop. This was a 36% rise compared to the EUR 17.4bn that it had bought during the week before last. Furthermore, it was the highest weekly amount so far this year and the second-highest ever. The split by programme type revealed that the bulk of purchases was made within the PSPP (EUR 20bn), followed by CBPP3 (EUR 1.7bn), the CSPP (1.3bn), and the ABSPP (0.7bn). As a result, the PSPP had an 85% share in total purchases, which was 75% in the week before last.

It will not be long before we see a new weekly record set, as the PEPP purchases were not yet included in the weekly numbers. However, Bloomberg reported that the ECB had indicated that it had already bought EUR 15.6bn under the PEPP, of which EUR 1.5bn was Commercial Paper. So, in total, the central bank bought almost EUR 40bn of assets last week, almost double the weekly record so far of EUR 24.6bn at the start of 2017. The fact that the central bank has focussed on the government bond and SSA market seems to suggests that its main goal is currently to compress government bond yields, which had started to rise since the start of March, adding to the tightening in financial conditions. (Joost Beaumont)