In the Eurozone it’s not just the European Central Bank which publishes its forecasts on a regular basis, but the European Commission also releases its own expectations. And those don’t necessarily agree with the ECB’s assessments!
In its Spring Economic Forecast, which was released last week, the EC is now clearly more positive about the outlook in the Eurozone as the Commission increased its GDP growth expectations by 0.1% to 1.7%, although it’s still warning for downside. This downside could be related to the decrease in inflation expectations. Yes, the official inflation rate will increase from 0.2% in 2016 to 1.6% in 2017 (thanks to the higher oil and gas prices), but according to the Commission, the inflation will start to trend down again and will fall back to 1.3% next year.
That’s an interesting view, and it shines a completely different light on the statement of the ECB, which was also released last week. As the ‘hard data’ coming out of the Eurozone are pointing in the direction of a continuously strengthening economy (with the factory orders in Germany finally picking up whilst the Netherlands and France saw a 4% and 3.5% increase in their manufacturing production results), the ECB was finally starting to think about reducing its monthly purchases of securities on the open market.
There has been a lot of chatter lately about ‘normalizing’ the monetary policy, but the expected parameters used by the Commission might cause the ECB to ‘re-think’ its plans. The unemployment rate on the Eurozone will remain relatively high at 8% in 2017 and 7.8% in 2018 and when you compare this to the much lower unemployment rate in the USA (less than 4.5%) it’s clear the situation in the Eurozone isn’t nearly as good as in the United States. Keep in mind we have no details on the underemployment rate in the Eurozone (compared to the USA), and whilst we would expect the ratio of underemployed people to be lower, we think the total percentage of unemployed and underemployed people will be in excess of 10% in the Eurozone.
Source: Danske Bank
So, is this good enough to start to normalize the monetary policies? It’s doubtful, and the ECB has to be very careful it’s not destroying the preliminary signs of the recovery of the Eurozone’s economy. It would make sense to first start to gradually decrease the monthly asset purchases. Not only because these asset purchases would be scaled back gradually, but also because it’s the easiest measure to reinstate should stepping down the size of the purchase program result in adverse effects. Nobody would lose his or her face if there would be a temporary suspension in the buyback rate, which would be less devastating than a ‘oops’ moment when trying to ‘reset’ the benchmark interest rates. But as you can see on the previous image, Danske Bank is agreeing with our assessment the inflation expectations might not be high enough to warrant the ECB to reduce its asset repurchase rate…
The ECB also literally said that whilst it expects its 60B EUR/month asset purchase program to run until the end of this year, its council could decide to extend this special measure until the inflation rate picks up again, and reaches the desired threshold.
Long story short, the ECB is and will be basing its policy decisions on the inflation expectations in the Eurozone. And if the European Commission’s expectations are correct, the ECB won’t be able to reduce its asset purchase program, further inflating and increasing the size of its balance sheet…