Just one year after Mario Draghi reassured the market he would do ‘whatever it takes’ to ensure the inflation rate in the Eurozone will increase again, he seems to have been pushed back into a corner. The European Central Bank once again had to reduce its economic growth expectations as well as the expectations for the average inflation rate in the Eurozone.
Despite the ECB having been a huge buyer of bonds on the open market to increase the liquidity in the system, the 60B EUR per month has been insufficient to create a serious trickle-down effect in the real economy. Whereas the central bank is targeting an inflation rate of 2% which it deems to be the ‘sweet point’ for a sustainably growing economy.
The inflation expectation for the entire year 2015 is just 0.1% and is expected to increase to 1.5% in 2016 and 1.7% in 2017. This also means that a negative inflation deflation in the next few months (on the back of a lower oil price) is a very realistic possibility now and it certainly looks like the ECB will have to step up its game to make sure it doesn’t lose control.
But it also looks like it has maxed out some bond purchases, as one of the newly-instated updates on the bond-buying program is an increased ceiling of how much the ECB can buy of one issue. Whereas the previous ceiling was placed at 25%, the ECB has now increased this level to 33% and the market is now widely anticipating Draghi to upgrade his Bazooka to a Bazooka 2.0 as the ECB is reportedly considering to purchase more different asset classes, to extend the current program (which is scheduled to end in 12 months from now) and to expand the program from 60B EUR per month to 75B+ per month.
The different players in the currency war are now taking their next steps at a very fast pace. After the Chinese crash and the devaluation of the Yuan, the USA will now very likely hold off on increasing the benchmark interest rate, now the ECB will very likely increase the liquidity in the system by a few billions per week, but the next step will be unfolded next week when China will announce an updated status of its foreign currency reserves.
Those reserves peaked at $4T in the summer of last year, but it will be very interesting to see how much of those reserves were dumped by China during its very agitated summer. The forex reserves dropped by in excess of $40B in July, but this number will very likely be much higher in August, and Netherlands-based Rabobank is estimating the outflow could be in excess of $200B as the Chinese central bank had to dump foreign currency in an effort to rescue the Yuan from a semi-freefall.
And this move could trigger another round of selling as Deutsche Bank expects the combined amount of forex sales from the central banks to be $1.5T in the next 16 months. Yes, that’s 1,500 billion dollar. And then the Federal Reserve will have to make the next move as a weaker Euro and Yuan is once again undermining the American economic growth.
The domino pieces are falling. Fast.
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