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Friday 31 July 2015

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NEWS

Today’s data calendar is problematic – there are plenty of scheduled releases of medium importance, so choosing the three most important ones is difficult.
Euro area July flash inflation (09:00 GMT). The median forecast is for a July inflation rate of just 0.2%, unchanged from June. The inflation rate is still well below the ECB's 2% target.

Chart source: Saxo Bank

The five-year forward breakeven inflation swap rose during the early part of 2015, and almost reached 1.9%, which is very close to the European Central Bank’s (ECB) 2% policy target. Unfortunately, when the oil prices begin to fall again in May, the inflation swap started to fall again and is now closer to 1.8%.

The M3 and M1 monetary aggregates have been increasing rapidly since mid-2014. Back then, the ECB first signalled its sovereign bond purchase programme plan, if other policy measures failed to lift the inflation outlook. Also the decline in private sector lending started to slow at that time, and for couple of months now, we’ve finally seen year-on-year growth.

All the important numbers – monetary aggregates, lending and inflation swaps bottomed out around the same time while the EURUSD peaked. Unfortunately, the amount of slack in Europe, mostly high unemployment, keeps inflationary pressure low. So it will take some time before inflation will return to the ECB’s target.

• Falling oil prices and high unemployment is keeping Eurozone inflation subdued
• Parts of the EU workforce have become structurally unemployed
• Bad ECB decisions contributed to Europe's jobless problem
• US employment costs are rising, giving the Fed the "green light" for a rate hike

Loss of faith in the system .. high youth unemployment in the EU was caused in part by poor ECB decisions, and it could have a big impact in Europe. Photo: iStock

This also makes ECB reactions less effective. A fall in oil prices could easily lead headline inflation to subzero levels, but the ECB could say that is just temporary and keep its eye on the inflation swaps and core inflation. All we can expect at the moment from the ECB is reminders that the sovereign bond purchase programme will be extended if needed, and that other measures are possible.

If the growth in monetary aggregates continue and the ECB governing council begins to worry about the bond purchase programme risk-sharing and possible losses, the language might tighten. The ECB’s durable path forward is narrow: too much or too easy risk-sharing alienates creditor nations' central banks, while selective or indecisive policy actions do not have the desired effect.

Euro area June unemployment Rate (09:00 GMT). The unemployment is expected to fall a little, but due to rounding, it will remain unchanged from May at 11.1%.

Big national differences in jobless rate

Chart source: European Commission


Clear regional divide on jobs

Chart source: Eurostat

Unemployment has been falling since mid-2013, and is now a full percentage point lower. However the rise of unemployment from the pre-crisis 7.5% to a high of roughly 12% is worrisome, as the rate for the long-term unemployed has increased from pre-crisis levels of just 3% to 6%.

A lot of this comes from bad policy. During Jean-Claude Trichet’s term, the ECB’s reaction to the crisis was weak, and often plain wrong: it hiked rates in 2008, even though other major central banks had already begun lowering them. In 2011, the ECB hiked rates twice. On the fiscal side, partly because of necessity but mostly out of choice, austerity measures were introduced, which hurt total demand.

The end result has been both movement along the Beveridge curve and a shift of the curve. There is a lack of aggregate demand in the Eurozone, but a lot of the damage is also permanent. Large parts of the labour force have become structurally unemployed, and high youth unemployment will have an even bigger impact in the long run.

US Employment Cost Index (12:30 GMT).
The index showed an increase of 2.6% from year ago levels in the first quarter, posting a quarterly increase of 0.7%. Similar numbers are expected from the second quarter. The current growth rate is fastest since 2008. The graph suggest a lift-off in employment costs has started. The core inflation rate is driven by wages. Other factors – food and energy – are too volatile to pay much attention to. So the Fed’s main interest is at what point do higher employment costs and low unemployment begin to feed to higher core inflation.

At least the breakeven inflation prices are not worried – the 10-year rate peaked on May 1 at 1.94% and is currently at 1.77% – but that is mostly due to low energy prices. There are enough reasons for the Fed to begin the rate hikes soon.
 Euro area annual inflation is expected to be 0.2% in July 2015, stable compared with June 2015 , according to a flash estimate from Eurostat, the statistical office of the European Union. Looking at the main components of euro area inflation, services is expected to have the highest annual rate in July (1.2%, compared with 1.1% in June), followed by food, alcohol & tobacco (0.9%, compared with 1.1% in June), non-energy industrial goods (0.5%, compared with 0.3% in June) and energy (-5.6%, compared with -5.1% in June).