April 19th, 2017
ECB Fixed Income NoteOn the impotency of the ECB’s monetary policy
• It’s hard to make the case that the ECB is actually responsible for the (recent) upswing in inflation when on the other side of the pond inflation is rising in tandem with Eurozone inflation – but with the difference that the Fed’s monetary policy is actually tightening, while ECB policy is not (yet) being tightened. Just look closely at the chart below. The red line is Eurozone HICP inflation (a seasonally adjusted index that makes for easy comparisons) and the Fed’s preferred price index, the Personal Consumption Expenditure (PCE) price index. ECB policy has been loosened pretty much without interruption since late 2013, while the Fed has been tightening policy gradually since the 2013 taper tantrum. The recent upswing in headline inflation in both jurisdictions primarily reflects the recovery in oil/energy prices, as we all know.
• The view that ECB policy hasn’t done much to boost prices is underscored by developments in core inflation. Here’s the HICP core price index. It has been rising at a trend pace of 1.0% since early 2013, while it used to increase at a trend pace of 1.5%.
- Is there hope for the ECB? Yes and no. Here’s core inflation performance compared in the US and Eurozone. I used the so-called market based measure of PCE core inflation, which excludes imputed measures (primarily homeowners’ equivalent of rent). That’s the closest we get to a US inflation measure that we can compare with Eurozone HICP. Note how core inflation in the US was equally disappointing, a situation that has only started to change since early 2016.
- The point that ECB President Draghi likes to make, is that the US economic cycle is far more mature. Thus, the US requires a different monetary policy stance than the Eurozone, where the recovery is far less advanced. Basically Draghi’s remarks boil down to the size of the output gap. Only when the economy nears full employment do (headline) inflationary pressures finally start to emerge – hence the belated upturn in US core inflation. In that sense, by running a ‘loose’ monetary policy the ECB is not boosting inflation, it’s preventing a slide into deflation. Bottom line, don’t wait for the ECB to ‘boost’ inflation, watch where growth, unemployment and wages are going to get a bearing on ECB monetary policy.