Monday, December 2, 2013

Euro zone inflation, unemployment and the ECB

Euro zone inflation ticked up slightly in November with the annual rate of headline inflation rising from +0.7% yoy to +0.9%.  Core inflation also rose from the 0.8% yoy to +1.0%.  Recent fears of deflation (at least in the true sense of the word) were overdone although we believe the Euro zone is in for a prolonged period of low growth and with that, low inflation.

Unemployment data was also a tad better with the unemployment rate moving down a tad from 12.2% in September to 12.1% in October.  This is noteworthy in that it’s the first decline in unemployment since early 2011 when the rate stood at 9.9%.  We don’t believe Euro zone growth will be strong enough in the period ahead to make significant inroads into unemployment any time soon.  It’s more likely that modest growth will be accompanied by at best a very gradual decline.  Call it secular stagnation if you like.

Both pieces of news will be welcomed by the ECB as they head into this week’s policy meeting.  There is however, still a significant job of work to be done to get the Euro zone growing and for inflation to even look like getting close to the ECBs definition of price stability.

The key to stronger growth in the Euro zone is the same as it always was – significant structural reform and stronger investment.  That begs the question what more the ECB can actually do.  As you know we believe cutting interest rates, as they did last month, is nothing more than symbolic.   Regular readers know we believe that too much responsibility has been placed on monetary policy to fix what ails some of the key developed economies in the post-GFC world.

Last week there was media speculation around other measures the ECB could employ.  That speculation included cutting the deposit rate and the possibility of another LTRO aimed at SME lending, most likely something similar to the UK’s “Funding for Lending" program.  We like the prospect on more focussed attention on business lending, especially in the SME sector where most new jobs are created.

On the subject of the UK’s funding for lending program last week the Bank of England and the Treasury announced a change to the program whereby incentives for mortgage lending would end but would continue for business lending.  That reflects recent strength in the housing market and consumption, but maintains support for the missing part of the recovery so far – business lending.  Without higher business lending we worry about the sustainability of the recent recovery in UK growth.  In terms of interest rates, the change means the policy rate can stay lower for longer.