EZ inflation, hard decisions | Calamatta Cuschieri

What to do in the face of an improving economy and accelerating inflation? Conventional wisdom tells us central banks should looks to tighten monetary policy to avoid runaway inflation and an ‘overheating’ economy. But when that economy is the Eurozone, and that central bank is the ECB, things are not so simple.

Facts first – the composite Purchasing Manager’s Index (PMI) climbed to 54.4 in December. That’s the highest in more than five and a half years, and higher than forecast. PMI value over 50 indicate economic expansion, as opposed to figures below which point towards a contraction in economic activity. Also – and more importantly – headline inflation climbed to 1.1% in the last month, the highest reading since September 2013.

The ECB is unlikely to be moved by the positive data however. Only last month, it extended its quantitative easing (QE) programme (albeit by lesser monthly amounts) and reiterated its dovish-leaning economic outlook. Any reversal of such a decision, or any indication of a rethink, would propel borrowing costs higher and dampen the, quote – “transmission of the monetary policy mechanism” – unquote.

Secondly, while a headline inflation reading of 1.1% may be favourably looked upon in isolation (remember, the ECB’s target is “close but below 2%”), a global analysis reveals inflation is still mostly subdued across all components bar one – energy. Much of the rise in inflation is in fact attributable to the rise in oil prices. If oil prices fail to increase or at least maintain current levels, it is not unlikely to see headline inflation fall lower across the next few months.

Market snippets

In auto news, General Motors said sales unexpectedly rose by 8% in December. Ford also beat forecasts, in the latest indication that 2016 results are set to beat record highs set in 2015. Shares in both companies rose at least 4%, and inventory levels were largely unchanged. On a more granular level, sales for the F-Series pickup truck – up 2.7% – led the gains for Ford. The model line remains the top-selling pickup truck in the US for the 40th (!) year in a row.

In rare news from the money-markets, the USD LIBOR seems to be responding to the recent rise in interest rates as the three-month rate hit 1.007% – the first ‘breach’ of the 1% level since May 2009. The much-maligned LIBOR is a benchmark for more than $350 trillion’s worth of global financial products.

Fed minutes

The greenback sold off on the news although it remains not far off from multi year highs against most of its peers

The release of the December Federal Reserve minutes showed that, although the US central bank recognises the potential boost to growth and inflation from – still on paper – potential tax breaks and infrastructural projects, those same policies may bring about an unwanted strengthening of the dollar. The greenback sold off on the news although it remains not far off from multi year highs against most of its peers.

The Fed also dropped some hints about the future path of interest rates, a.k.a. the dot plots. These were only slightly higher than in previous meetings, prompting 10-year Treasury yields to drop below 2.41% intraday.

This article was issued by Andrew Martinelli, Trader at Calamatta Cuschieri. For more information visit, www.cc.com.mt. The information, view and opinions provided in this article is being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice. Calamatta Cuschieri Investment Services Ltd. has not verified and consequently neither warrants the accuracy nor the veracity of any information, views or opinions appearing on this website.