The increasingly short-termist attitudes of both policy-makers, analysts, and investors leaves market and economic indicators in the US and Europe all anticipating some magic in 2013. If only we can get through the elections, the fiscal cliff, a banking union, a Spanish bailout request, Greek extensions; not to mention another round of weak earnings and a sliding Chinese demand backdrop. As SocGen's FX and Rates desk notes, the battle against disinflation in Europe is not over and nominal GDP outlooks remain far too optimistic - only highlighted by the morning's weak lending data.
The deleveraging has a long-way to go! following Japan's path...
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Via Societe Generale's Cross Asset Research
EU Disinflation: Battle Not Over
Weak eurozone lending data for September, published this morning, sent a pretty stark warning to policy makers not to expect much, if any, improvement in the economy over the coming months. It also suggests that inflation can only head ower and a review of the ECB’s nominal growth projections for next year may need trimming back.
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All other things being equal, this also suggests that, in fundamental terms, there is no strong case for long-term EU rates and swaps to rise meaningfully in the foreseeable future, and instead the core yield curve should retain a flat bias if the pessimistic growth scenarios play out.
The moribund growth backdrop also begs the question what palpable difference any relief over Spain or Greece (if it comes) will do to the long end. The answer is probably not a whole lot. Lower inflation and nominal growth should keep a lid on long core yields, even if bailout costs for the periphery continue to rise (Greek debt extension). Though CPI inflationin the eurozone has been rather stable, oscillating around 2.5% for most of this year, a series of downbeat data this week (PMIs, IFO, unemployment) validate ECB president Draghi’s assertion yesterday (made in front of German lawmakers) that the threat of disinflation is currently greater than inflation, and that the OMT will not alter that course. The extent to which central banks are factoring in a fall in inflation was highlighted this morning when Sweden’s Riksbank almost halved its inflation forecast for 2013 to 0.7% from 1.3%. Momentum is still swinging in one direction.
With lending levels in Spain and Italy now even lower, in annual terms, than during the depth of the recession two years ago, but with the trend also worsening in France and turning in Germany, it is indeed difficult to envisage inflation staying at the current levels in the EU this winter. As the chart below illustrates, declines in credit growth have in the past resulted in reduced price pressures.
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Increases in indirect taxes to meet strict EU deficit rules are temporary, but they are negative for private sector consumption and investment and therefore will only reinforce the trend.
This should help real EU yields edge higher after having fallen below those of some its major G10 peers.
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Real yields in Japan continue to hover around 100bp, but Sweden is rapidly closing the gap. Real rates in the UK too have picked up, but a short-term rise in inflation may bring the uptrend to a (temporary) halt.