Global Daily – The ECB’s inflation worry

by: Nick Kounis , Aline Schuiling

ECB view: Meeting account reveals concerns about inflation, euro and second wave – The account of the September Governing Council meeting signalled that officials were concerned about the inflation outlook despite the upward revision in the staff projections. ECB Chief Economist Philip Lane noted in his presentation to the group that ‘inflation was expected to remain persistently low over the medium term, notwithstanding a gradual pick-up over the projection horizon’ and that ‘there was a clear risk that the negative shock to the path of inflation as a result of the pandemic could give rise to a renewed downward trend in inflation expectations’. He also admitted that although ‘temporary factors had distorted the August figure, underlying price pressures had likely weakened owing to subdued demand and significant labour market slack’.

Meanwhile, Governing Council members seemed to have doubts about the macro staff projections. The account notes that ‘the argument was made that the inflation outlook in the September staff projections appeared too optimistic. The situation in the labour market could be expected to lead to weaker wage pressures over time. Moreover, Phillips curve estimates, in particular those incorporating the output gap or using total hours worked rather than the unemployment gap, tended to show lower inflation compared with the September baseline’. Even on the basis of the baseline ‘inflation remained below the Governing Council’s aim over the projection horizon, notwithstanding ample policy support’.

The Governing Council also expressed some concern about the possibility of a further surge in the euro. It was asserted that ‘given the openness of the euro area economy…a further appreciation of the exchange rate constituted a risk to both growth and inflation’. However, ‘it was recalled that a significant impact of the exchange rate appreciation on euro area inflation had been included in the September 2020 ECB staff projections’ and ‘it was suggested that it was the pace of the euro’s appreciation, rather than the level of the exchange rate, that could become a concern’.

Finally, officials underlined the downside risks related to developments with regards to the virus. Members underlined ‘that while the baseline scenario assumed that the virus was largely under control, there was considerable uncertainty surrounding the future evolution of the pandemic and the development of a vaccine (and) many countries were now experiencing new outbreaks of the virus. In some parts of the euro area, the resurgence of the virus was assessed to be affecting the recovery and the probability that other countries would have further outbreaks was seen as very high’.

It seems to us that developments in both inflation and the virus since the September Governing Council meeting would have further fuelled the ECB’s concerns about the outlook. However, the ECB may take a more sanguine view on the exchange rate given the stabilisation in the euro over recent weeks. Following the meeting account we remain very comfortable with our base case of a EUR 500bn step up in the PEPP in December. We do not expect a rate cut currently. We think this is a tool to curb euro strength, while the euro’s upward trend has recently halted. However, a second upward leg of the single currency would make a rate cut a distinct possibility. (Nick Kounis)

Euro Macro: Spectacular, yet temporary, growth rebound takes shape in Germany – Germany’s monthly economic activity data for July and August have illustrated that a sharp rebound in GDP growth in Q3 is taking shape. If we look at the 3month-over-3month growth rate (which reflects the monthly moving average growth rate during the quarter) industrial production increased to 8% in August, up from -16.1% in June. This means that, if production were to stabilise in September, the quarter-on-quarter growth rate would jump to 9.8% in Q3, up from -16.1% in Q2. Similarly, exports expanded by almost 15% 3m-o-3m in August, up from almost -22% in Q2. Stabilisation in September would mean that quarterly growth in exports would accelerate to almost 20% qoq in Q3. As the rebound in imports has remained more modestly, there will be a large positive contribution from total foreign trade to Q3 GDP growth (of around 9 percentage points assuming stabilisation in September, compared to a 6 percentage points reduction of growth in Q2). Finally, retail sales and car registrations combined indicate that consumption growth shot up to round 4.5% qoq in Q3, up from -10.9% in Q2. Taking everything together we have pencilled in GDP growth of around 8% qoq in Q3 up from -9.7% in Q2.

Looking beyond Q3, it is important to note that the sharpest acceleration in the monthly activity data took place in the months May and June and that growth has slowed down noticeably then. Indeed, industrial production declined by 0.2% mom in August, while export growth slowed down to 2.4% mom in August, down from 4.7% in July. Monthly growth in the combination of retail and car registrations fell to 0.7% m-o-m in August down from 1.4% in July. What is more, the composite PMI declined somewhat in August-September compared to July, while consumer confidence (GfK measure) declined in September-October compared to August and the rise in the Ifo business climate lost momentum in August-September compared to June-July. Indeed, we think that the sharp rebound in growth in Q3 will be followed by a slowdown in growth to close to zero in Q4. (Aline Schuiling)