Mario Draghi, ECP president © Getty Images
Even central bankers can learn from their past mistakes. The package of measures unveiled on Thursday by the European Central Bank is an intelligent response to the criticisms levelled against it for the debacle of its previous, underwhelming easing in December, and against the Bank of Japan for its misguided experiment with negative rates last month.
The announcement by Mario Draghi, ECB president, represents just about the best effort that can be adopted nowadays to use unconventional monetary policy to restore inflation to target. It is not overly huge in scale, but is multi-faceted and well directed at the special problems plaguing the eurozone economy. Read more
A few months ago, this blog commented that a rise in inflation in the advanced economies early in 2016 was “almost certain”. Thank goodness for the word “almost”. Since then, oil prices have plumbed new depths, and the markets have remained obsessed with fears about deflation.
The case for higher inflation in 2016 rested on the fact that the impact of energy on headline consumer price inflation would change direction when oil prices stabilised. This “inevitable” arithmetic effect has been delayed by the slump in oil prices in January, but it should manifest itself in the near future.
The key question, though, is whether this automatic rise in headline inflation presages a more important turning point for underlying inflation in the advanced economies – a turning point that has been wrongly predicted for several years now.
The answer is that there are some tentative signs of a slow rise in underlying inflation in the US, where price increases have been higher than expected in recent months. In contrast, inflation rates in the Eurozone and Japan have surprised on the low side. There, fears of “secular stagnation”, leading to deflation, still seem all too real. Read more
Global risk assets have rallied in the last two weeks, encouraged by signs of policy changes in China and the US Federal Reserve, and also by buoyancy in retail sales growth in the US. While this has reduced the markets’ assessment of global recession risk, compared to the dark days in early February, the Fulcrum “nowcast” models have actually moved slightly in the opposite direction. Full details of the monthly nowcasts are available here.
The world economy is still very far from a recession, but the nowcasts show clearer signs of a slowdown in global activity growth. This probably started in early 2015, but the downward momentum has gathered pace since the beginning of 2016. The model’s estimates of global GDP growth (blue line) have declined from 3.4 per cent in late 2015 to 2.9 per cent now, a development which warrants careful monitoring.
It is clear that the advanced economies have slowed significantly since last November.
The estimated US growth rate has remained sluggish at around 1 per cent, so growth in the advanced economies has continued to decline, and is now running at only 1.0 per cent, which is markedly below trend and still dropping. It is true that some alternative estimates for US growth (including the Atlanta Fed nowcast) suggest that the growth rate may have rebounded from 1 per cent in 2015 Q4 to about 2 per cent in the current calendar quarter. But the Fulcrum models have done a good job in identifying the continuous US slowdown in the past 12 months, so their bleak message should not be discounted.
The key change this month is a further decline in the growth rate in the eurozone. This is a distinct change in the pattern identified by the models in late 2015, when the eurozone was the strongest of the major advanced blocs. This situation has changed sharply in the past two months, with the German economy becoming markedly weaker. Read more
The latest and, so far, the most severe scare about global deflation started with the oil price collapse in mid 2014, and reached its peak with the sharp drop in global industrial production in mid 2015, swiftly followed by the Chinese devaluation episode in August. Fears of an imminent slide towards a global industrial recession haunted the markets, and both expected inflation and bond yields in the advanced economies approached all-time lows.
But, just when everything seemed so bleak, the flow of economic information changed direction. Global industrial production rallied, and China stabilised its currency. On Friday, the US jobs and wages data were much stronger than expected. Inflation data in the advanced economies have passed their low points for this cycle, and the rise in headline 12-month inflation in the next three months could surprise the markets.
This certainly does not mean that the repeated warnings of the inflationistas will suddenly be proved right. It may not even mean that long-run deflationary pressures in the global economy have been fully overcome: global growth rates are still below trend, and spare capacity is rising in the emerging world. But the peak of the latest, commodity-induced deflation scare is in the past. Read more
The extreme turbulence of the financial markets in August resulted in a temporary rise in the Vix measure of US equity market volatility to levels that have been exceeded on only a few occasions since 2008. Markets have now settled down somewhat, but it is far from clear whether the episode is over. In order to reach a judgment on this, we need to form a view on what caused the crisis in the first place.
The obvious answer is “China”. The response of the Chinese authorities to the stock market bubble, and the manner in which the devaluation of the renminbi was handled, raised questions about policy credibility that added to ongoing concerns about hard landing risk in the economy. The conclusion that a China demand shock was the main driving force behind the global financial turbulence was given added credence by the simultaneous collapse in commodity prices, and in exports from many emerging economies linked to China.
It would be absurd to deny that China had an important role in the crisis of August 2015. But was it the only factor involved? After all, China’s growth rate does not seem to have slowed very much. Furthermore, standard econometric simulations of the impact of a China demand shock on the major developed economies suggest that the effects should not be very large, and certainly not large enough to explain the scale of the decline in global equity prices, or in the “break-even” inflation rates built into US and European bond markets.
It is conceivable that bad news from China triggered a sudden rise in risk aversion among global investors that exacerbated the shock itself. It also possible that markets were responding to the fact that the Federal Reserve apparently remained determined to raise US interest rates before year end, regardless of the new deflationary forces that were being triggered by events in China.
New econometric work published today by my colleagues at Fulcrum suggest that the perception of an adverse monetary policy shock may have been important in explaining the financial turbulence, in which case the Fed needs to tread extremely carefully as it approaches lift-off for US rates. Read more
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As the Greek drama dominated news bulletins throughout the first half of 2015, there was generally little impact on global financial markets, outside Greece itself. It is true that eurozone equities underperformed the world equity market after mid April, but the euro actually strengthened over this period, and the yield spreads between peripheral eurozone bond markets and German bunds widened only slightly, at least until this week.
This general aura of market calmness had consequences for the talks themselves, since it emboldened the Germans and other EU negotiators to take an even harder line with the Syriza-led Greek government. With no hint of a concession to take back to Athens, Mr Tsipras had nothing to sell to the left of his party.
Paradoxically, the fact that the markets remained quiet for months has therefore increased the chances of a major accident taking place as political nerves fray.
The prolonged period of market insouciance should not lull any of Europe’s leaders, headed towards Brussels for an emergency summit on Monday, into a false sense of security. There is no guarantee that the markets would remain relaxed in the case of a Greek default or exit from the euro. The real test starts now. Read more
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Ever since the collapse in oil prices started last summer, the behaviour of the global economy and financial markets has been heavily affected by the consequences of lower energy prices. Now, however, there is gathering evidence that the primary effects of the oil shock have been absorbed into the system, and there are signs that other forces are beginning to take control. What are these forces, and how will they affect the global economy in the months ahead?
When the oil shock reached its maximum early in 2015, economists were largely agreed on its likely impact. Since it seemed to stem mainly from the supply side of the oil market, not the demand side (a fact corroborated by IMF research last week), it was thought likely to boost real global GDP growth this year by about 0.5-0.75 per cent, leading to a break-out in global growth to the upside. It also had a dark side, increasing the deflation threat in the eurozone and Japan, but this was likely to be offset by further aggressive monetary easing by their respective central banks. Read more
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When the Brazilian finance minister Guido Mantega complained that the Federal Reserve was waging a currency war against his country in September 2010, his comments led to a wave of sympathy and concern. The Fed’s aggressive monetary easing was causing a capital flight from the US into the apparently unstoppable emerging markets.
Uncompetitive exchange rates and domestic credit booms in the EMs were the result of US quantitative easing. American monetary policy makers showed little sympathy, arguing that the US had its own domestic inflation and unemployment mandates to worry about. If the dollar fell in the process, so be it.
That episode proved short lived. The Brazilian real is now a chronically weak currency. Yet the term “currency wars” has stuck. It is now alleged that almost all the major central banks are engaged in weakening their currencies, if not against each other then certainly relative to commodities, goods and services. Read more
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And then there were none. On Thursday, the European Central Bank became the last of the major central banks to announce a large programme of quantitative easing, involving the purchase of over €1tn of assets, mostly eurozone government bonds, in the next 18 months.
Is this the “credible regime change” which economists like Paul Krugman say is the only way that central banks can affect growth and inflation when interest rates have reached the zero lower bound? It would be too optimistic to say “yes”, but it is certainly a major philosophical shift by the conservative standards of the ECB. Originally designed slavishly on the Bundesbank model, the ECB has declared independence from its German forebears today.
But the long delays in reaching this point have made the eurozone deflation threat more severe than it need have been. Whether this belated recognition of reality is a case of better late than never, or too little too late, remains to be seen.
The markets are likely to assess the package with three litmus tests: is it big enough, are the restrictions placed on the bond purchases too restrictive, and does it matter that the decisions were far from unanimous, with the Bundesbank probably opposed to some key elements? In my view, the good clearly outweighs the bad. Read more
he oil price has fallen by more than half in a little over six months, and you might expect investors to be cheering. Perhaps they would have been — had the result not been a precipitous drop in inflation.
A flight to the safety of government bonds has caused yields to fall lower than they have been at any time other than the darkest days of the euro crises of 2012. Although stock markets are still only 3.5 per cent from their all time highs, they have become a lot choppier. Prices are bouncing up and down, suggesting investors have become more nervous about the prospects for economic growth. Read more
The simmering row between the European Central Bank president Mario Draghi and the German Bundesbank president Jens Weidmann is sometimes painted in personal terms, but in fact it epitomises a wider difference between the hawks and the doves on the ECB governing council. It is important to understand the anatomy of this dispute as the central bank prepares for its next critical meeting on December 4.
The dispute is fundamental and longstanding. Mr Draghi has adopted the New Keynesian approach that dominates US academia and central banking. There is really no difference between the philosophy that underpins his latest speech and that of Ben Bernanke, vintage 2011-13. In contrast, recent remarks by representative hawks such as Mr Weidmann and ECB executive board member Yves Mersch stem directly from the Austrian school of European economics. It is no wonder that these differences are so difficult to bridge. Read more
The examination is over. For more than a year the European Central Bank has been shining a light on the books of the eurozone’s banks; this weekend it reported its conclusions.
The balance sheets of 25 institutions were found wanting; the ECB concluded that they need an extra €25bn between them to be able to withstand a nasty economic surprise. Two crucial questions remain. Has enough at last been done to fix the European banking system? And will this on its own be enough to ward off the threat of deflation that is hanging over the eurozone? Read more
© CARLO HERMANN/AFP/Getty Images
Last week’s press conference by ECB President Mario Draghi left the markets disappointed and somewhat perplexed about the shift towards quantitative easing that had just been sanctioned by the governing council (GC). Because this was focused on private sector assets, in the form of asset backed securities and covered bonds, there were doubts about whether the new policy could be implemented in sufficient size to deal with the deflationary threat in the euro area.
Mr Draghi was noticeably hesitant about giving any firm indication about the likely scale of the programme. Although private sector quantitative easing (QE) is likely to suit the needs of the euro area rather well, as I argued here, the absence of any firm guidance on scale certainly undermined the beneficial announcement effects of the policy change.
The ECB president addressed this issue on Thursday in an appearance at Brookings in Washington. This time, freed from the need to speak for the entire GC, he clearly changed his tune on the scale of the programme. But this highlighted the extent of the gap between his view and that of Bundesbank President Jens Weidmann, who presented his position in a revealing interview with the Wall Street Journal on Monday. It is far from obvious how this disagreement will be bridged. Read more
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Mario Draghi’s remarkable speech at Jackson Hole has raised expectations that ECB purchases of sovereign debt will be soon announced by the governing council, if not this Thursday, then perhaps by the end of the year. In all the excitement about QE, the importance of Mr Draghi’s remarks about fiscal policy have gained less attention in the markets.
Mr Draghi’s speech broke new ground for an ECB president, and this could herald a significant change in the stance of fiscal policy in the entire euro area. Unusually, fiscal policy could be as interesting for markets as monetary policy in the months ahead.
Traditionally, ECB presidents have always argued in favour of fiscal austerity, and have of course refused to countenance any form of monetisation of budget deficits. The stance on monetisation changed a few months ago, and now even the Bundesbank accepts that QE is within the terms of the treaties.
But the Germanic approach to the fiscal stance (ie the level of budget deficits, as opposed to how they are financed), is only now being seriously questioned by the ECB for the first time. Not surprisingly, this is reported to have triggered consternation in Germany, and approval in France.
Mr Draghi’s new views on fiscal policy stem from a change in his underlying analysis of the economic problem facing the euro area. This has led the ECB president to throw his weight behind a fiscal plan which is slowly emerging from the European Commission, in conjunction with France and Italy. Now that the ECB has gone public on this, the pressure on Germany to give ground has increased markedly. The debate on this subject within Germany itself is clearly becoming crucial. Read more
Although the European Central Bank took no concrete action on Thursday in the face of a decline in consumer price inflation to only 0.5 per cent in March, president Mario Draghi’s statement contained new language which has moved the goalposts for future action by the bank. By stating that the governing council is now unanimously willing to adopt quantitative easing in order to cope with prolonged low inflation, the statement substantially alleviates the risk of secular “lowflation” that has been worrying investors for some time.
To recognise the importance of this change of stance, consider what the ECB has said about QE in the past. A few years ago it tended to dismiss the option on the grounds that it was too close to direct financing of government budget deficits, and was therefore against the terms of the euro treaties. More recently, while becoming gradually less dismissive of QE on constitutional grounds, it has been unwilling to concede that unconventional monetary easing was necessary, saying that conventional measures were still available, and would be used first. Read more
The leading central banks in the developed economies have, of course, been the main actors underpinning the global bull market in risk assets since 2009. For long periods their stance has been unequivocally dovish as they have deliberately tried to strengthen an anaemic global economic recovery by boosting asset prices.
In the past week, we have had major statements of intent from Janet Yellen, the new US Federal Reserve chairwoman; from the European Central Bank; and from the Bank of England. After multiple hours of fuzzy guidance about forward guidance, the clarity of previous years about the global policy stance has become much more murky. Central banks are no longer as obviously friendly to risk assets as they once were – but they have not become outright enemies, and they are unlikely to do so while they are concerned that price and wage inflation will remain too low for a protracted period.
It is now quite difficult to generalise about what central bankers think. However, a few of the necessary pieces of the jigsaw puzzle slotted into place in the past week. Read more
As we enter 2014, the five-year bull market in developed market equities remains in full swing. Recently, I argued that equities now look overvalued, but not egregiously so, and that the future of the bull market could depend on when the level of global GDP started to bump up against supply side constraints, forcing a genuine tightening in global monetary conditions.
Today, this blog offers a year end assessment of three crucial issues that relate to this: the supply side in the US; China’s attempt to control its credit bubble; and the ECB’s belief that there is no deflation threat in the euro area. At least one of these questions is likely to be the defining macro issue of 2014 and beyond. Read more
For many years, one of the most enduring mantras of central banking was along the lines of “we never pre-commit to future actions, because all of the information we have about the state of the economy is already contained in the actions we have just announced”. Now that has been completely abandoned. With the ECB and the BoE changes announced today, the central banks are shouting from the rooftops that “we are all forward guiders now”.
In the old days, if the central banks wanted to ease or tighten policy, they just adjusted the size of the change in interest rates at any given meeting, and allowed their actions to speak for themselves. The forward path for short rates was generally very sensitive to any given change in the policy rate, so they did not have to worry too much about the impact of their policy on the yield curve. Read more
The ECB decided yesterday against “going negative” by reducing its deposit rate from zero to -0.25 per cent. The Governing Council again debated the pros and cons of such a measure, which would represent the first time that any of the major four central banks would ever have reduced a key policy rate to below zero . Mr Draghi said again that the ECB was “technically ready” to take this action, and that the option remains “on the shelf”.
Many in the markets believe that this is just a bluff to prevent the euro from rising in the foreign exchange markets. There have been several unsupportive comments from leading members of the Governing Council (Asmussen, Mersch, Noyer and Nowotny) and Mr Draghi admitted that disagreements exist in the Council. Nevertheless, the President has deliberately left the option on the table, so it is important to understand the debate.
The technical aspects of negative rates have been very well covered in FT Alphaville recently, but I would like to focus on the broader policy implications. Why would a central bank want to take this action, and could it back-fire on them? Read more
Fiscal austerity, a concept which German Chancellor Merkel says meant nothing to her before the crisis, may have passed its heyday in the eurozone. This week, the European Commission has published its country-specific recommendations, containing fiscal plans for member states that are subject to excessive deficit procedures. These plans, which will form the basis for political discussion at the next Summit on 27-28 June, allow for greater flexibility in reaching budget targets for several countries, including France, Spain, the Netherlands and Portugal.
Furthermore, there have been rumblings in the German press suggesting that Berlin is beginning to recognise that fiscal consolidation without economic growth could prove to be a Pyrrhic victory. If true, this could mark the beginning of a new approach in the eurozone, helping the weakest region in the global economy to recover from a recession that has already dragged on far too long. So how real is the prospect of change? Read more