Markets
In case you haven’t noticed it yet, the ECB is in full swing towards policy normalization. ECB President Lagarde acknowledged upward inflation risks at the previous ECB meeting. Executive board member Schnabel made a plea to take higher costs of home ownership into consideration when assessing inflation. For Q3 2021, she calculated that it would have added 0.6 ppt to core inflation (1.4%). Banque de France governor Villeroy doesn’t want Frankfurt’s hands to be tied for too long and calls net asset purchases to end in Q3.
ECB chief economist Lane completed the U-turn on inflation at an MNI Market News webcast yesterday. He said that it is unlikely that inflation will drop below 2% in the next two years. That’s a big head’s up to the new March inflation projections which will thus show an upgrade of the 1.8% figure for 2023 and that way warrant a different path going forward in terms of asset purchases. Lane did try to make a little nuance. He thinks that inflation will settle around the 2% target in the medium-term, which permits a gradual normalization of policy, i.e. winding down net asset purchases and getting rid of negative policy rates. For the ECB to really engage on a tightening cycle, Lane argues that there needs to be a threat that inflation will persist significantly above 2% over the medium term.
Money markets currently discount the latter scenario with a return to zero by the end of the year and a projected policy rate peak between 0.75% and 1% by the end of 2024. Our own scenario currently takes into account a 0.75% policy rate by the end of 2023.
Markets didn’t react to the symbolic Lane comments. General trends remained at play. Simply put: a fragile risk sentiment on stock markets, correcting core bonds and numbed FX markets. Main European equity indices lost up to 1% yesterday with US losses reaching up to 2.9% for Nasdaq.
US yields lost 5.2 bps to 8.4 bps with the belly of the curve outperforming the wings. The German yield curve bull steepened with yields sliding by 3.3 bps (30-yr) to 6.6 bps (2-yr). 10-yr yield spread changes vs Germany narrowed by up to 3 bps.
EUR/USD closed at 1.1361 from an 1.1373 open. Sterling continued its recent outperformance ending below EUR/GBP 0.84 for the first time since the ECB/BoE February policy meetings.
January UK retail sales this morning beat consensus. They grew by 1.9% M/M for the headline number and by 1.7% M/M for the core retail sales. The increase was driven by a pickup in spending on household goods and at garden centres. UK markets don’t react. Earlier this week, we’ve had a good labour market report and higher inflation numbers. The combination of these data keeps the BoE clearly on the normalisation path.
News Headlines
Contrary to price developments in many other countries, price rises in Japan in January remained subdued. Japan’s headline CPI eased from 0.8% Y/Y in December to 0.5% Y/Y. The closely watched measure excluding fresh food eased to 0.2% Y/Y, from 0.5%. Ex-fresh food and energy, prices even declined 1.1% Y/Y. All measures were lower than expected. Even so, Japanese inflation is expected to rise later this year as a base effect of a cut in mobile fees last year will drop out of the data. Energy prices rose 17.9% Y/Y. Even so today’s data suggest that Japanese firms remain reluctant to pass through higher input prices to end consumers. The yen eases slightly this morning. USD/JPY (115.25) regains the 115 handle after a risk-off driven setback yesterday/early this morning.
According to Reuters, a proposal to revive the 2015 nuclear deal with Iran is to work out subsequent steps that parties have to fulfil. A 20 page draft is said to include that Iran needs to halt enrichment of uranium above 5% purity. Other steps are said to include unfreezing of $7bn in Iran funds blocked at South Korean banks and the release of Western prisoners in Iran. The lifting of restrictions on the country’s oil sector would only come later in the process. As was the case in the original deal, the US would grant Iran waivers on sanctions rather than removing them all-together. The implementation of this whole process, assuming an agreement will be reached, can still take a few months. Brent oil this week eased from a top near $96.75 p/b to $92.75 currently.
