This week promises to be a big week not only for US economic data, with the latest US jobs report on Friday, but Europe as well as the European Central Bank meets for the final time this year, with expectations high that the governing council could well ease key interest rates further into negative territory, when they meet on Thursday. Currently the deposit rate sits at -0.2% which means in essence, banks pay the central bank to hold money for it. That would make sense if inflation was running the region of -0.3%, or deflation, but it isn’t. Rising expectations that the deposit rate could be cut further has prompted yields on 2 year German bonds to slide to as low as -0.4%, while those paragons of European fiscal virtue, Italy and Spain have also seen their 2 year yields slide into negative territory. We are told by eminent ECB policymakers on condition of anonymity that the bank must do something due to the fact that the economy is in deflation, and that several options are being considered including charging banks a fee for parking cash overnight, with the bigger banks paying a higher fee. It is hard to imagine that this type of intervention will find favour with Germany and France who have the biggest banks and the smaller euro zone banks aren’t likely to be too happy either, particularly since the European banking system still has about €1trn of non-performing loans. With the euro close to multi year lows against the US dollar it is slowly becoming clear that the ECB is determined to drive the euro down even lower in an attempt to import some form of inflation whatever the cost. The one problem with this story is that, despite the shock of the terrorist attacks in Paris, the European economy does appear to be showing some signs of life, with the latest economic data hitting levels last seen four years ago, and unemployment starting to fall back as well. Furthermore contrary to what ECB policymakers are saying core inflation is running at 1.1%, while headline inflation, including food and energy is running at 0.1%, well above the level of -0.6% which prompted the ECB to start its QE program in March this year. Recent comments from ECB President Draghi would appear to suggest that the ECB could well extend QE, increase the monthly amount and cut rates as well. All three of these seem completely at odds to what the economic data is telling us right now. Furthermore the effects of the fall in oil prices is likely to drop out of the inflation numbers in February, giving a further upward boost to the headline CPI numbers while unit labour costs in Europe are also starting to rise again, which suggests that market expectations are running ahead of what the ECB is likely to deliver on Thursday. Quite simply there is a risk that market expectations of what the ECB will do this week are based on the premise of shock and awe, when in reality they could get something more akin to bubble and squeak. The material (whether or not it states any opinions) is for general information purposes only, and does not take into account your personal circumstances or objectives. Nothing in this material is (or should be considered to be) financial, investment or other advice on which reliance should be placed. No opinion given in the material constitutes a recommendation by CMC Markets or the author that any particular investment, security, transaction or investment strategy is suitable for any specific person.
ECB expectations could well disappoint
19:00, 30 November 2015 · By Michael Hewson