Friday, January 23, 2015

Thanks for checking in...

I'm away for a few days enjoying the summer sun.  Back early February.

Wednesday, January 21, 2015

Data Insight: NZ CPI

Key points:

  • New Zealand’s December quarter CPI came in at -0.2% q/q and +0.8% y/y.  That was weaker than our expectations of -0.1% q/q.
  • As expected the fall in oil prices was the primary downside contributor with petrol prices falling -5.7% over the quarter.  Further petrol price falls will be reflected in March data with the CPI likely to fall -0.3% in that quarter.
  • The weakness in the quarter went beyond just petrol however with general weakness across the traded goods sector.  The high exchange rate remains the likely culprit.
  • The annual rate of inflation is now below the bottom-end of the RBNZ’s target band again.  It will head lower in March and on our current forecasts is expected to remain below 1% for all of this year. 
  • While this may be causing the RBNZ some discomfort, there is not much they can do about it.  They can’t cut interest rates given the strength in the housing market and signs of rising capacity pressures, even though that is not yet reflected in consumer prices. 
  • Nor should they do anything about it.  The dip lower on the back of weaker oil price will prove transitory.  The Bank should look through that in the same way they should look through price shocks to the upside.
  • That said, general inflationary pressures have been weaker than expected and the Bank is clearly ahead of the curve.  But we continue to believe the next move in interest rates is up although that now appears a 2016 story.
  • Where interest rates head from here will not be determined by the price of oil but rather the extent to which the New Zealand economy can to continue to grow at an above-trend pace without generating inflationary pressures.  That will largely be determined by the extent to which wages respond to continued falls in the unemployment rate.

Sunday, January 18, 2015

Data Insight: US CPI

Key Points:
  • The U.S. Consumer Price Index fell -0.4% mom in December as the sharp drop in oil prices continued to make its mark.  Petrol prices fell -9.4%in the month and are down 21% over the year.  This result took the annual rate of CPI inflation down to 1.2% yoy.
  • Central banks will focus on the extent to which lower oil price feed through into the prices of goods and services beyond the fuel pump.  The December data shows clear evidence of some flow through with core inflation flat over the month.  The annual rate of core inflation is now +1.6% although the last three months shows an annualised increase of just +1.1%.
  • The split of core prices into goods and services gives us some confidence the low core inflation result is fuel related.  Services prices showed a small rise over the month while goods prices declined.  Goods price seem more likely to be impacted by lower transportation costs and the recent strength in the USD.
  • We expect to see further softness in core inflation in the months ahead.  While a pickup in spending on the back of lower oil prices appears likely, businesses don't yet have sufficient pricing power to expand margins.
  • We know the FOMC won't wait for inflation to be at 2% before raising rates, but they will want to be sure there is a solid floor under core inflation before starting to tighten.
  • With likely further pass through of lower oil prices into core inflation in the months ahead, coupled with still low wage growth, it may be later than mid-year before the FOMC feels sufficiently confident that inflation is returning to target to increase interest rates.

Thursday, January 15, 2015

ECJ ruling opens the door to QE - but will it work?

For a quantitative easing program to be in any way effective in the Euro zone it must be large and unconstrained.  Up until now there have been two potential constraints to an effective asset purchase program – opposition from the German Bundesbank, primarily on the issue of risk sharing, and a pending ruling from the European Court of Justice (ECJ) on the legality of the earlier Outright Monetary Transactions (OMT) program.

Overnight the ECJ issued a non-binding opinion that, subject to a number of small conditions, the OMT is consistent with the EU Treaty.  Furthermore the opinion stated that the ECB should have “broad discretion when framing and implementing the EU’s monetary policy”.  Couldn’t agree more.

A final ruling from the ECJ is due in a few months but it seems unlikely will be substantially different from this opinion.  In the meantime this has removed any legal barriers to the announcement of a sovereign debt purchase program by the ECB on January 22nd. 

During the course of last year the ECB took a number of steps to support the flagging economy and to boost persistently low inflation.  They cut interest rates (including the introduction of a negative deposit rate) and launched the TLTRO, the take-up of which has been disappointingly low in the first two tranches.

Since then core inflation has continued to drift lower to a level that is uncomfortably low, a reflection of a persistently large output gap best indicated by an unemployment rate that remains chronically high at 11.5%.

The oil price fall has added to the disinflationary forces at play within the euro zone which is now in (technical) deflation.  While orthodox monetary policy suggests the ECB should look through the oil price shock, broader disinflationary forces are already well entrenched.  Furthermore it seems the oil price fall has greatest chance of spilling over into core inflation in countries where demand is weakest.  The euro zone fits the bill admirably.

The ECB rhetoric has stepped-up recently to the extent that a sovereign debt purchase program is now fully priced in by markets, thereby already delivering the decline in bond yields and a lower currency the ECB will be hoping will support growth and bolster inflation.  The risk for markets (and the euro zone economy) is the ECB underwhelms expectations next week.

So expect the ECB to announce a sovereign debt purchase program as part of its commitment to expand its balance sheet by €1 trillion, although some detail is likely to be unresolved.  A QE program in the euro zone is obviously more complex than it is in the likes of the US, the UK or Japan.

The ECJ opinion also reduces the effectiveness of opposition from the Bundesbank which fears the sharing of risk of sovereign bond purchases by the ECB will covertly lead to the introduction of Eurobonds.  I don’t have a problem with that as I still think some form of debt mutualisation is inevitable if the Euro is to survive as a common currency.   That concern can be mitigated if each national central bank to purchase its own sovereign bonds with no pooling of risk.  That seems to me to be a second best solution to large and unconstrained action by the ECB.

But will it work?  The ECB will be expecting the expansion of the monetary base, lower yields and greater liquidity to support rising asset prices to all contribute to stronger credit and GDP growth.  A lower exchange rate are will bolster inflation and add to competitiveness. In that respect it’s a necessary step along the path to higher growth and inflation.

But will it be sufficient?  Probably not.  Have a (re)read of Mario Draghi’s speech from Jackson Hole last year and you will see even he thinks monetary policy alone cannot fix what ails the euro zone.  Monetary policy needs mates in the form of growth enhancing fiscal policy and structural reform, especially in the labour market.

I’m often asked whether QE worked in America.  Apart from the obvious impact on interest and exchange rates, the important contribution it made was to buy time for the economy to heal itself.  But that was in the most flexible, nimble, innovative, dynamic economy on the planet.  The euro zone doesn't have that luxury.