The noose around the ECB’s throat is tightening but what policy options are left?

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Tomorrow the Governing Council of the European Central Bank meets and at 12.45 pm (interest-rates) and 1:30pm (extraordinary measures) will let us know its latest policy moves. In the holiday season on December 30th I pointed out that the ECB would be spending the break considering what to do next and 2014 has opened along the lines of these lyrics by Glenn Frey.

The heat is on, on the street
Inside your head, on every beat
And the beat’s so loud, deep inside
The pressure’s high, just to stay alive
‘Cause the heat is on.

This morning the message was reinforced by the unemployment new from the increasingly troubled Italy.

In November 2013 the unemployment rate was 12.7% (+0.2 percentage points over October).

A bit like the scoring rate in a one-day cricket match the Italian unemployment rate has risen inexorably from the 11.3% of November 2012 to the 12.7% of this year. The youth (15-24) unemployment rate has now risen to 41.6% from Octobers’s 41.4% and is 4% higher than a year before.

This grim news is reinforced by the employment numbers which should be of more significance to the ECB as they have proven to be something of an economic leading indicator at times in the credit crunch. Via google translate.

The employment rate , at 55.4 % , decreased by 0.1 percentage points in economic terms and by 1.0 points compared to twelve months earlier.

Some 55,000 fewer people were employed over the month and 448,000 fewer than a year before. So the ECB will be considering both a record unemployment rate since it began to be recorded 37 years ago or a doubling since 2007 as well as falling employment in Italy.

The inflation issue

This is something which unlike some central banks the ECB does take seriously so let us remind ourselves of its objective.

The Governing Council has also clarified that, in the pursuit of price stability, it aims to maintain inflation rates below, but close to, 2% over the medium term.

So far its battles on this front have been with inflation being in danger of over-shooting its target but it does claim to treat its doppelganger equally.

By referring to “an increase in the HICP of below 2%” the definition makes clear that not only inflation above 2% but also deflation (i.e. price level declines) is inconsistent with price stability.

The latest data

The Euro area consumer price index was updated only yesterday.

Euro area  annual inflation  is expected to be 0.8% in December 2013, down from 0.9% in November.

So if we are truly to get a symmetric response then the ECB should respond with the same enthusiasm that it woud reply to an inflation rate of 3.2%. Also in an example of being hoist by your own petard the core inflation rate which central bankers often like to trumpet fell to an annual rate of 0.7% in December.

If we look further down the inflation chain then the prospects look set for more of the same.

In November 2013, compared with October 2013, industrial producer prices  fell by 0.1% in both the euro area   (EA17) and the EU28

In November 2013, compared with November 2012, industrial producer prices decreased by 1.2% in the euro area and by 1.0% in the EU28

As you can see producer prices are exhibiting outright disinflation as they are falling on both a monthly and an annual basis. So weak current consumer inflation is likely to come under downwards pressure over the next few months from this source.

If we look wider for guidance then we see that the oil price has begun 2014 by weakening slightly to around US $107/8 per barrel and commodity prices seem to be in the downtrend which began a year ago. Accordingly there is little or no sign of inflationary pressure from these sources to be seen right now.

For those who expect Germanic resistance to all of this well actually the inflation numbers there are weak too right now. Indeed producer price inflation was negative there too on both a monthly basis (-0.1%) and an annual basis (-0.7%) in November and the annual figure looks to be trending downwards.

What about output and growth?

Having nudged its way out of overall recession the Euro area will be hoping for growth in 2014 but it starts with only a weak push from the end of 2013.

At a three-month high of 52.1 in December, up from 51.7 in November the final Markit Eurozone PMI®   Composite Output Index rose to its second highest level in the past two and a half years.

There has been a debate recently over whether one should regard 50 as this series for unchanged or a range of 49-51 or 48-52 which might be why the recovery is called “modest and fragile overall”. The output effect is estimated below.

consistent with a mere 0.2% expansion of GDP during the final quarter

Although it was optimistic for prospects for the beginning of 2014.

 the region as a whole looks set for a strengthening recovery in 2014

Another issue is the economic divergence in the Euro area where the Germanic locomotive has been joined by Ireland and Spain but seems to be going in the opposite direction to both Italy and France. Some care is needed with Ireland as the PMI series there sometimes disconnects with industrial production completely.

Existing monetary policy

This is a bit all over the place at the moment. The easing theme comes from the interest-rate cut made in November which reduced the official rate to 0.25%. Of course the catch is how much of this was actually passed on in the countries which most needed it. On that road it looks more of a public-relations exercise than a real policy move frankly.

This has been joined by a further fall in peripheral government bond yields. Leading this particular pack right now is Spain which has seen its ten-year yield drop to 3.78% as I type this. Actually let me widen this to the whole Iberian peninsula as Portugal has seen its equivalent bond drop to 5.25%. So some of the pressure on budgets in these nations will be eased a little as debt costs drop. However the economic impact of falling bond yields has tended to disappoint if the record of Quantitative Easing in other countries is any guide.

Monetary Tightening

Here there are two associated problems for the ECB. Firstly the amount of bank lending to businesses in the Euro area continues to decline as November saw a 3.9% fall on a year before. Secondly the balance sheet of the ECB itself has continued to shrink and whilst the holiday brake increased the numbers 2013 ended on a weak note.

Accordingly, on 23 December 2013 EUR 4050.00 million will be repaid in the tender 20110149 by 6 counterparties and EUR 16675.00 million in the tender 20120034 by 11 counterparties

Actually much of this is being caused by the ECB’s own financial regulation section and its asset quality review.


If the ECB was a pure inflation targeting central bank then we could expect further easing soon. Actually we know that it does often operate in that manner to inflation over-shooting so we await its response to an under-shoot. Also we note that it does have secondary objectives too.

Without prejudice to the objective of price stability”, the Eurosystem shall also “support the general economic policies in the Union with a view to contributing to the achievement of the objectives of the Union”. These include inter alia “full employment” and “balanced economic growth”

I would suggest that today’s news release means that it is a very long way from full employment.

The euro area  (EA17) seasonally-adjusted  unemployment rate3  was 12.1% in November 2013, stable since April (up from 11.8% a year ago).

So easing is on the cards here too. Except that the ECB has very few tools for dealing with the economic divergence that is currently prevalent in the Euro area. Except perhaps for its head Mario Draghi calling the various political leaders on his speed-dial and telling them to do something for once.

Do all roads then lead to Rome? Perhaps not tomorrow as Mario Draghi only recently told us this.

At the moment we see no need for immediate action.

Perhaps they can also cling to the retail sales numbers which showed a monthly rise of 1.4% in November according to Eurostat. But nonetheless I expect there to be suggestions of more easing expressed at the Governing Council with them however being a minority this time round.

The other problem is what to actually do? With the bond yield falls that are already happening then Quantitative Easing to further reduce them seems rather pointless. Perhaps they will copy the Funding for Lending Scheme of the Bank of England badging it for business lending and being “disappointed” if instead it helps the housing market. this would of course be another implicit subsidy for the Euro’s area banks….



This entry was posted in Euro zone Crisis, European Central Bank, Forward Guidance, Inflation, Quantitative Easing and Extraordinary Monetary Measures and tagged , , . Bookmark the permalink.
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  • forbin

    Hello Shaun,

    Great news ! Euro area infaltion is going to disinflation !

    Everyones Euro will buy more and we’ll all be richer! Hurrah!

    except of course that these guys dont think that way …. they truely really believe that people will put off purchasing goods ( core goods that they don’t ) need for a perceived gain later on

    never been proved !

    so how do they destingushe between lower wages and what people have being spent on food,fuel and housing , thus not having the money to buy a new iphone ?

    Well they can’t , so we’ll have QE by any name you care to choose and as newt said in the Aliens films

    “it won’t make any difference”

    grab another bag of popcorn, Shaun , and lets see what these bozos come up with ;-)


  • JW

    Hi Shaun
    ‘Gold Standard’ ( German productivity) fiat ( Euro) or ‘Monetised’ fiats ( USD, GBP, Yen)? Fiscal austerity or inflation?
    The inflated GDP numbers in the ‘anglo’ economies certainly look better, low paid, part-time jobs better than no jobs. But is it sustainable? Will the disinflation of the EZ prove ‘better or worse’? ( and how do you define ‘better’ in this looking glass world).
    Reduced living standards for the majority are baked into all these economies, ‘politics’ defines how they are perceived, but the reality is the same for the vast majority.

  • Anonymous

    Great column, Shaun. Since you show the industrial producer price estimates for the euro area and the EU, you may be interested in knowing that the Canadian industrial product price indexes (the Canadian equivalent to the PPI) were revised to adopt 2010 expenditure weights on Monday, Orthodox Christmas Eve. Besides the much poorer timeliness in implementing the revision as compared to Europe, the Canadian revision was noteworthy for the eight-year gap separating the new basket reference year 2010, from the previous one, 2002. Although the documentation for the industry price index series says that it is policy to revise to new expenditure weights every five years, the actual gap between basket reference years has exceeded five years before as this complete list of basket reference years indicates: 1981, 1986, 1992, 1997, 2002, 2010 The 2004 IMF producer Price Index Manual clearly states that expenditure weights should be revised at least every five years, so StatCan was way out of line in delaying this revision so long. As yet, only data for January 2010 forward have been released on the new base, but absurdly, StatCan has no intention of pushing back 2010 expenditure weights to 2009, as the UK Office of National Statistics did when it revised to 2010 expenditure weights more than a year ago.on 12 November 2013.
    Bias in industry price indexes doesn’t get nearly the same amount of analysis as bias in consumer price indexes but the principles are the same: the less frequent are basket revisions, the greater the upward substitution bias in the index. So it is reasonable to believe that there is considerably less upward bias in the British or European PPIs than in itheir Canadian counterpart.
    Andrew Baldwin

  • Anonymous

    Hi Forbin

    There is a certain irony in a time when disinflation is being discussed so much that the (toffee) popcorn I like went from 85p to £1 per bag! Mind you on that subject there is some food inflation in the Euro area as prices rose by 1.8% in the last year (although you have to add in alcohol and tobacco).

    Of course for the official bodies it is the debt that is the problem which does not respond to falling prices. As ever Greece is the extreme case where real GDP growth has pretty much been matched by falling prices meaning that currently even good news does not help her that much in debt terms.

    The Greek people by contrast will welcome both trends..

  • Anonymous

    Hi JW

    A seemingly likely development in the UK confirms your view in the last paragraph I think. Whilst an above inflation rise in the minimum wage would be welcome for those getting it (assuming it doesn’t lead to any job cuts) it strikes me as a classic tactic. Take the good PR from such a move and hope that people do not notice that wage growth remains weak otherwise….

    It will be interesting to see how much disinflation affects the Anglo economies especially the UK. The major reason why I have been quiet on the subject of base rate rises is the strength of the pound which for once is working counter-cyclically for the UK. But it often overshoots and if it does so again (pushes above US $1.70 and Euro 1.25 say ) we could see the UK run under its 2% CPI target for a bit…

  • Anonymous

    Hi Andrew

    These issue are ones which the various statistical bodies have a duty to do regularly. I was reading an article on inflation in Germany at the weekend and it stated that Destatis only reviews the CPI weights every 5 years which is too in frequent especially in the fast changing credit crunch era. The UK ONS does so annually for CPI and RPI and I think that is the best way forwards.

    Did StanCan have any explanation for its tardiness in this area?

  • Anonymous

    Thank you for your reply, Shaun. The Germans do revise their CPI backwards just like the UK PPI so it is not quite so bad. However, I don’t believe they revise past the actual basket reference year when they introduce new expenditure weights, so the current 2010 expenditure weights are only used from 2010 forward. It seems that when the West Germans went from a 1962 basket to a 1970 basket, they took the new 1970 expenditure weights back to January 1968, but they seem to have abandoned this very good British practice since then.

    I agree with you that annual chain linking is best. I think the best of all official CPIs, as far as the index formula is concerned is the Swedish CPI, which is an annual-link chain Walsh formula. However, it does have the drawback that it must be revised, and over a rather long period of 24 months.

    StatCan had no explanation for why it was so late. The 2002 expenditure weights were only introduced very late, in 2010. They could have, and probably should have, introduced the 2007 expenditure weights the very next year, but they chose to pass over the 2007 expenditure weights altogether.

  • sancho panza

    Fascinating discussion Slavophile and Shaun.