Markets
ECB president Lagarde at the ECB Watchers Conference went into more detail on the central bank’s potential response to the energy shock. The strategy is based on three key principles. The first is to assess the nature, size and persistence of the shock before taking decisions on policy. The ECB must identify when higher energy costs risk spilling over into broad-based inflation – be it through indirect effects or through second-round effects via wages and inflation expectations. Lagarde admitted 2026 isn’t 2022 but its legacy lingers in the minds of consumers and businesses and this may prompt quicker pass-through effects. Yesterday’s PMIs are case in point. Secondly, the ECB focuses on risks – which may get non-linear – and not only the baseline. That translates into the third principle: having a set of options for how to respond, which depend on the intensity and duration of the shock and how it propagates. Lagarde then went on to point to three broad cases which, reading between the lines, basically correspond with the ECB’s baseline (A), adverse (B) and severe (C) scenario published last week. An energy shock limited in size and short-lived (A) would be looked through. In case of a shock leading to a large though not too-persistent overshoot of the 2% inflation target (B), some measured adjustment of policy could be warranted, also from a communication & signaling point of view. If inflation is expected to deviate significantly and persistently from target (C), the response must be appropriately forceful or persistent to prevent self-reinforcing mechanisms to kick in and risk a de-anchoring of inflation expectations. It is too soon to determine which scenario is prevailing, Lagarde noted. But in an echo to BoE’s Pill “fog of uncertainty cannot be an excuse for inaction” yesterday, the ECB president sounded resolute: “But we will not be paralyzed by hesitation: our commitment to delivering 2% inflation over the medium term is unconditional.”
Lagarde’s speech came against the backdrop of the US having ramped up diplomatic efforts to end the war with a 15-point proposal and a one-month ceasefire. Iran, however, already rejected the proposal. It has 5 conditions to begin talking about the end of the war, with “international recognition and guarantees of Iran’s sovereign authority over the Strait of Hormuz” probably not landing well in the US. Markets nevertheless take the optimistic view with stocks rebounding around 1.3% in Europe and 0.7-1.3% in the US. Brent oil fell towards the $100 barrier, down from $104.5 yesterday but up from intraday lows. European yields fell 6 bps across the curve at the open before entering a sideways trading range afterwards. Gilts hugely outperform with net daily changes varying between 8-12 bps despite above-consensus and -target February inflation numbers even before the Iran war erupted early March. The US curve bull flattens, showing declines up to 2.4 bps. Currency markets trade calm with a small US dollar bias. EUR/USD eases to sub 1.16, DXY moves higher towards 99.34. USD/JPY hovers around the recent highs just south of 160 (158.9 currently). Sterling treads water around EUR/GBP 0.865.
News & Views
In speech on purchasing power and the real cost of living in New Zealand, Reserve Bank of New Zealand Paul Conway observes that New Zealand is an expensive country, with prices for many products well above the OECD average. Since the pandemic, prices overall have risen by 26%, with prices for some essentials increasing by much more. Income per person has increased by slightly more, suggesting little change in purchasing power. Before 2020, purchasing power of wages grew faster than the OECD average, supported by strong employment growth and favourable terms of trade. Currently wage purchasing power is around the OECD average, but about 20% below the average of the more advanced economies. Monetary policy can anchor prices but can’t make New Zealand more affordable on its own. Sustained gains in purchasing power require higher productivity. Indicators suggest that the quality of structural policies in parts of New Zealand’s framework lag behind OECD best practice. On the current monetary policy stance, Conway indicated that he still sees excess capacity in the economy. At the April 8 meeting, the RBNZ will assess how much it has to lean against the wind in terms of potential rate hikes going forward. Markets see the RBNZ starting rate hikes in summer (May only 30% discounted), which might accelerate later with OCR near 3% discounted around year end. The Kiwi dollar underperformed the Aussie dollar already before and after the conflict in the Middle East started. NZD/USD eased from a peak just below 0.61 end January to currently 0.582.
