If Mario Draghi was waiting for the latest Eurozone inflation data to cement his decision to unleash negative deposit rates, if not more, in the Eurozone, he got it earlier today when Eurostat reported that May inflation tumbled to 0.5% - matching the cycle lows and the lowest since March 2009 - down from April's 0.7%, below the 0.6% expected, and less than half the ECB's target. In other words, despite everything tried in Europe nothing is working, and the most important chart - that showing the collapse in lending to private companies - not due to lack of supply but due to no demand, continues to be the most relevant one. Sadly, it is the one Draghi has shown over the past three years he has virtually zero control over.
Broken down by segments, the biggest drop in prices was in Energy and non-energy industrial goods, with food and alcohol rising a modest 0.1%, as services rose by the most or 1.1%.Still, even the core number of 0.7% came in below the 0.8% expected and down from 1.0% in April.
The commentators quickly commented:
“It’s a surprise, but not enough of a surprise to change materially the global economic outlook that the ECB will release on Thursday,” said Michel Martinez, an economist at Societe Generale SA in Paris. “What seems highly likely is that the ECB will cut key rates and probably also inject further liquidity.”
"Today's inflation numbers underscore the need for the ECB to act. The ECB has consistently underestimated the deflationary forces threatening Europe and now is the time for unconventional monetary policy," said Dominic Rossi, Global Chief Investment Officer at Fidelity Worldwide Investment.
The market response, as we already noted, was paradoxical, with Bunds selling off on the data:
German 10-year government bond yields, which hit 12-month lows last week, rose 3.1 basis points to 1.34 percent. Bund futures declined. Some traders said the weak inflation data was already priced into the market and prompted investors to book profits after a recent rally.
"That number was if anything bond-friendly. We expect the Bund to regain its momentum and start rallying again ahead of Thursday's ECB meeting," one trader said.
And now everyone looks forward to Thursday's ECB monthly announcement, curious what non-existant bazooka Draghi will pull out of his sleeve. As Bloomberg summarizes, the ECB has prepared investors for the prospect of stimulus when it announces the rate decisions on June 5. “We are ready to act,” ECB Vice President Vitor Constancio said on May 30. “We are not complacent about the risks from a protracted period of low inflation.”
“The ECB will announce rate cuts, including the deposit rate into negative territory,” said Martinez, who was one of the few economists accurately to forecast the May inflation rate in Bloomberg’s survey. The ECB will probably also stop sterilization of its Securities Markets Program and announce a targeted longer-term refinancing operation, Martinez said.
However, a possible interest rate cut by 0.1 to 0.15 percentage point would have little impact, as the rate tool has been exhausted, former ECB chief economist Juergen Stark wrote in today’s Frankfurter Allgemeine Zeitung.
As for negative rates? Well, let's look at the example of Denmark which introduced negative rates nearly two years ago. Did it have an impact on lending? As the following chart courtesy of @GreekFire23 shows, the answer is: not at all.
None of this matters: what does matter is for the ECB to exude confidence and pretend like it knows what it is doing even as it is becoming increasingly clear that the reality is anything but.