Uddrag fra Unicredits Erik Nielsen:
Today, I’ll discuss two closely related issues:
■ I’ll revisit the ECB’s post-strategy-publication media blitz to explain and persuade the public ahead of Thursday’s Governing Council meeting that they’ll act “forcefully and persistently” to achieve the revised inflation target – raising expectations in the process. And I note the decision to take the digital euro project a step further.
■ As summer rolls in and most of the OECD economies show strong growth, the debate about the withdrawal of policy stimulus is picking up on both sides of the Atlantic. Yet, there is still a long way back for a full recovery in Europe and the list of unanswered questions about the strength and sustainability of the path back to recovery is long.
I’ll summarize my seven key questions – and, as a summer-special, I’ll illustrate them with a set of attached charts. To me the conclusion is clear: Any reduction in European policy stimulus would be a mistake. If you disagree after having read my note and looked at the charts, do write to me!
1. The ECB: The blitz to persuade that the revised inflation target is attainable, raising expectations – and the next step on the digital ladder. I’m a bit of a sceptic on both. Last Sunday, I discussed the ECB’s Strategy Review, published on 8 July, and how it was missing the “instruments” part – or, in other words, “how they’ll deliver the revised inflation target”. As I noted, it was politically critical to have the strategy agreed on unanimously, and that – by virtual definition – prevented any inclusion of the specifics of “how” to achieve it.
But the lack of a persuasive list of available instruments, and the explicit commitment to use them to the extent needed, came at a price: Marketbased inflation expectations dropped back again, far below the target. During this past week, Christine Lagarde and her Executive Board colleagues have been doing a commendable number of interviews and presentations to explain the strategy in more detail – and to convince people that after ten years of missing the “below but close to 2%” target, now they’ll manage to hit the “2%” over the medium term.
The key arguments, as I understand them, are that the strategy was agreed on unanimously and that they’ll now act “forcefully and persistently” and not necessarily unanimously – and that this will be clear already at their next meeting on Thursday when we’ll see a sharper communication and a re-worked forward guidance. One thing is clear, the expectations of more aggressive action have been raised, but will they deliver?
I would love to be persuaded on Thursday, or during one of the following meetings, but I remain skeptical. Without a doubt, we need more than words (including in the form of forward guidance) to bring inflation closer to the target. In my book, the ECB already acted “forcefully and persistently” during the Draghi years, as well as in reaction to the pandemic, but it was still insufficient to reach the inflation target and yet, it led to the well-known rifts in the Governing Council. Should we now expect even more forceful measures in terms of purchases and/or terms for the TLTROs as well as commitments via forward guidance – and the (virtually inevitable) deeper conflict between the factions at the GC? – And this precisely at the time when the hawks are getting increasingly vocal about their desired tapering of the PEPP? I doubt it.
Or could the ECB redefine “the medium term” (for the inflation target) to a longer period beyond the commonly understood period that’s defined by their forecasting horizon? I have noted a couple of suggestions that maybe “medium term” and the “forecasting horizon” may not have to be the same. I surely hope this is a misunderstanding. It would overnight change any remaining belief in the inflation target as a meaningful guiding objective for policies into nothing more than a Fata Morgana. 18 July 2021 Macro Research Chief Economist´s Comment UniCredit Research page 2 See last pages for disclaimer.
As the ECB mentioned in its background paper, the old inflation target had become unattainable for monetary policy alone, given the structural forces and fiscal policy. These past 18 months have seen the power of well-coordinated fiscal and monetary policies, but – as I’ll discuss in the next section – the prospect of keeping fiscal policy on a sufficiently supportive path is not looking good. My conclusion was – and still is – that the best thing for the ECB to do in such circumstances is to explicitly commit to keep the sovereign curves in place until inflation is back at its (revised) target, and then commit to the then achieved inflation target.
Short of that – and short of explicitly putting truly powerful weapons on the table, including an extension of the PEPP or other QE with all its flexibility to underwrite a forceful yield curve control, if not even helicopter money, as recommended, e.g., by Chair of the French Council of Economic Analysis, Philippe Martin and co-authors) – the fog between the present and the target will remain too thick for comfort. Please do look out for my colleague, our Chief European Economist, Marco Valli’s take on Thursday’s meeting.
Unrelated (sort of), the ECB announced this past week that they’ll move their digital euro project forward with a more detailed “investigation phase” that will last two years. If that leads to a decision to roll out a digital euro, this would then be expected to take at least another three years. (The relation to the strategy review is – I assume – that the indicated timing of the next strategy review will be in 2025, at which stage the ECB would have a good sense of what they want to do in the digital universe and what the implications for policies might be.) I’ll be writing more about this in the future, I’m sure, but my present view is that:
(i) it’s the right decision to further investigate the possibilities and implications of a digital euro, but (ii) a digital euro is unlikely to pass the bar of usefulness, yet (iii) it may well pass the bar of not causing visible costs or harm, which may then – given the zeitgeist – become a sufficient criterion for it to be launched one day. At the most basic level, my skepticism is rooted in the fact that for legitimate businesses, all payments are already digital (but the payments’ systems should certainly be upgraded) and for retail use we already have a digital euro for anyone, and (practically) any use, at no cost to whoever desires to transact in the digital universe.
That digital euro is, of course, a claim on a bank or asset manager (as opposed to the physical cash which is a claim on the ECB), but my euro claim on my bank is guaranteed up to EUR 100,000 – multiple times the suggested EUR 3-4,000 cap on digital euro claims on the (safe) ECB. So why should I – or anyone else – bother with one more account? As a personal anecdote, which may illustrate my skepticism.
I have actual experience with the privilege of holding non-cash claims on a central bank: As a young economist, I worked for a few years for the Danish central bank and those days, such employment came with the pleasure of a personal account with the central bank – and a check book for that account. I can reveal that apart from the occasional comment or question from the recipient of my checks like “I didn’t know you could have an account there” or “what bank is that?”, the privilege of holding such a (non-physical-cash) claim directly on the central bank came with no benefit in terms of anything relative to my previous – and subsequent – accounts with commercial banks. Meanwhile, the central bank had “bankers” who serviced us “customers”, at some (hidden) cost to society.
Not surprisingly, therefore, the privilege for Danish central bank employees of holding non-cash claims directly on the central bank has since been discontinued. I’m open to persuasion, and I think it’s right for the ECB to investigate further, but I haven’t yet seen a persuasive case for what problem it’s supposed to resolve, or prevent.
2. Strong growth, but a long way back to “recovery” – and there are still more questions than answers when it comes to the strength of the growth path. The following discussion is illustrated in a deck of charts, the link is here: UniCredit Research outlook: The re-opening! I’ll do my best to make the text readable with or without the charts – and the charts should be sufficiently self-explanatory to be understood without reading the text, if that’s your preference. First, as I’m sure you are aware, the forecasting community all seem to have virtually identical forecasts. At UniCredit Research, we forecast global GDP to expand by 6.1% this year, followed by 4.6% next year.
We see the US and the eurozone expanding by 6.6% and 4.5%, respectively, this year, followed by 3.8% and 4.3% in 2022. As illustrated in Chart 2, this is very close to the present forecasts by the IMF, European Commission and the OECD (and by consensus for that matter). 18 July 2021 Macro Research Chief Economist´s Comment UniCredit Research page 3 See last pages for disclaimer. Indeed, the slight differences reflect mostly the timing of the publications: The more recent the forecast, the stronger it is, as it then incorporates the recent stronger-than-expected indicators, e.g., the PMIs, as shown in Chart 3.
We use parts of the PMIs – along with other statistically significant early indicators – to produce our proprietary Global Leading Indicator, which continues to point toward very strong growth in global trade in the third quarter (Chart 4). But here’s what’s critically important to appreciate when people speak about “recovery” and possible policy changes: In spite of the strong growth rates now, and the near-unanimous expectations of more of the same, eurozone GDP remains some 5% below its pre-pandemic level, and it won’t get back to that level until around year-end.
The hope of catching up with the extension of the pre-pandemic trend line (let alone restore the lost territory during these past two years) – which is what “a recovery” would mean in any normal interpretation of that word – remains elusive in anyone’s forecasts. This stands in sharp contrast to the US, which has already surpassed its pre-pandemic GDP level and is on track to catch up with its trend line around year-end (Chart 5). Nonetheless, the present strong growth rates have already led to calls in Europe for some withdrawal of stimulus already now.
To me, a withdrawal of stimulus this year or next would almost certainly be misguided in the extreme. As noted, by no reasonable definition can one argue that the European economy has “recovered” from the effect of the pandemic, and if you ask any experienced forecaster, he or she would tell you that the growth path between here and the full recovery is more uncertain than anything one can recall. Furthermore, the risk to the downside is at least as prominent as the risk to the upside – and, I would argue, the consequences of withdrawing stimulus too early are measurably more severe in the present economic and political environment than the consequences of keeping the pedal to the metal a bit too long.
The following are my seven most important questions when it comes to the outlook (I list them in Chart 6 for the ease of reading the charts separately):
Question 1: How will the infection rates develop at a time when new variants are spreading, the apparent reluctance by 30%- 40% of the US and European adult population to get vaccinated and the still missing (approved) vaccine for children (representing close to one fourth of the world’s population) – and the uncertainty with respect to the effectiveness of some of the vaccines to the variants? The relatively good news from the UK is that, while the infection rate for the Delta variant is now increasing at an alarming pace, the hospitalizations have not, which suggests that it’s less severe, at least for those who are vaccinated – all illustrated in Charts 7 and 8. Still, if the pandemic spreads in a new wave, pressure from medical advisors will build on governments to lock down again, although I suspect most governments will be reluctant to do so for business reasons. But even so, as can be inferred from Chart 9, and verified by research by, e.g., the IMF, even without formal lockdowns, voluntary restrictions on mobility – as the fear factor increases – has almost as much impact on activity as if formal lockdowns were in place.
So, the big question remains whether global GDP can recover properly so long as roughly a third of the OECD adult population resists vaccination and very big parts of EM haven’t even started a proper vaccination program. I think not; consequently, for me, almost all the risk to the commonly agreed growth forecast from the pandemic remains on the downside.
Question 2: Will the present inflation spike be temporary or the beginning of a more fundamental shift? While the pickup in inflation has been stronger than expected in the US, we remain firmly in the “temporary camp” – for both the US and Europe. As illustrated in Chart 10, even in the US, the increase in the inflation index is driven by huge jumps in a very small number of items, which can all be explained by extraordinary factors. And as long as that’s the case, the transmission to wages and hence to a more potent version of inflation is very hard to imagine. For example, in the US June inflation number, price-jumps for used cars account for no less than one third of the increase in the entire index.
As Bloomberg’s Tracy Alloway quipped on Twitter: “so we should definitely be watching what happens to the wages of people who make used cars. That’s gonna be big”. And while the price of airfares was up almost 25% in June, they are still some 10% below their pre-pandemic level (h/t Vitor Constancio). I think Kenneth Rogoff is absolutely right when he argues in the FT: “Don’t panic: a little inflation is no bad thing”; here: https://www.ft.com/content/a7c101be-7361-4307-981d-b8edf6d002be In this light, it is not surprising that inflation expectations, as implied by markets, have no more than returned to their pre-pandemic levels after their early-2020 dip, and for the US they have even started to decline again as market participants began to better understand the dynamics (Chart 11). 18 July 2021 Macro Research Chief Economist´s Comment UniCredit Research page 4 See last pages for disclaimer.
For Europe, the risk of the temporary inflation turning into a longer-term problem is even slimmer than for the US. Indeed, nobody that I’m aware of forecast eurozone HICP inflation at more than around 1.5% by the end of next year (Chart 12) – and that’s well appreciated by the ECB. If you haven’t read it, I highly recommend Isabel Schnabel’s excellent speech on “Escaping low inflation?” some two weeks ago: Petersberger Sommerdialog – 3 July 2021
Question 3, and for the longer-term inflation outlook, a big question mark hangs over the outlook for oil prices. In the short term, we are rather obsessed with supply issues, of course, but central banks should – and will – look through those. Yet, as years of lofty rhetoric about climate change is about to turn into policies in a more serious manner across big parts of the world, one has to wonder about oil. As illustrated in Chart 13, on IEA estimates, if the world manages to get to net-zero by 2050, global oil demand will drop from 95-100 mb/d to some 70 mb/d already within the next ten years. All else being equal, that will provide long-term structural downward pressure on global inflation – which will be (partly, fully or more than?) offset by upward pressure on prices for equipment needed for green energy production.
The net effect remains difficult to anticipate, but one thing is clear: We’ll be in for years of significant relative prices changes, and if that happens in a generally low-inflation environment, then it’ll be more burdensome on activity than if it can take place in a higher inflation environment. I’m now turning from these bigger external questions to the question about how people and businesses may react during the next phase of the pandemic:
Question 4 relates to the households and their elevated savings levels. As illustrated in Chart 14, at the end of the first quarter (latest data), excess savings as a result of the pandemic and lockdown in the eurozone equaled about 6% of 2020 GDP, ranging from some 5% in Germany to 8.5% in Italy. In the US, excess savings stand at a whopping 12% of GDP.
Thus, the question is: Will households spend the extra cash quite quickly, or more slowly, as – or if – the pandemic peters out and economies open up again, or might they even want to keep a higher level of precautionary savings in the future now that they have experienced this type of crisis? When thinking about this, it seems important to consider the sources of the excess savings. As illustrated in Chart 14, in the US, it’s all generated by cash transfers to households’ disposable income, while in Europe more than 2/3 of the excess saving is the result of reduced spending, and even more extreme in Southern Europe. The difference reflects the different fiscal responses: Grossly simplified, in the US cash was sent to people’s bank accounts (or by check) with a message that “here’s some cash for you to survive” unemployment and other disruptions, while in Europe, the support came mostly through subsidies to keep people in their jobs, even if there was no work to do.
All else being equal, as a result, US households may be more likely to treat their excess savings as a wealth gain, which historically implies that only a very small part of it will be spent over the next couple of years. However, to the extent the cash transfers were made to the part of the population with very low, if any, savings, which indeed appears to be the case, then a much higher share will likely be spent quite fast. In Europe, where the excess saving predominantly reflects delayed spending, a greater share is likely to be consumed sooner – although there is still a limit to how many vacations most of us can take in a year … My point is this: As forecasters, we have no reliable experience with his this type of reactions by households, adding to the immense uncertainty.
Question 5 relates to the future behavior of non-financial corporations, which took on massive amounts of (mostly government-guaranteed) debt during the pandemic, but used this to build huge liquid buffers – illustrated as the difference between net and gross debt in Chart 15. As the world normalizes, what will these firms do: Use the spare cash to pay down debt? (yes, probably, particularly if governments announce an end to the guarantee schemes) – or will they use the cash to invest? (yes, if the guarantees remain in place and they see demand for their products pick up.) And finally, I turn to the two policy questions for Europe: How will fiscal and monetary policy react during the next 6-12 months – a period which, again, will most likely be characterized by strong growth, an incomplete recovery, and loads of unknowns.
Question 6 relates to the future path of fiscal policy. I have written a lot about this in recent months, so I’ll keep it extremely short here: As illustrated in Chart 16, the fiscal effort, including NGEU and automatic stabilizers, in Europe is moderate this year, at best. Different estimations of the cash disbursements, automatic stabilizers, etc., might get us a total number broadly in line with the estimated output gap, but there seems virtually no “risk” of overshooting the gap. This is a key reason why the ECB’s chance of meeting its inflation target (unless they step up the use of their arsenal very significantly) remains slim. It’s also the key 18 July 2021 Macro Research Chief Economist´s Comment UniCredit Research page 5 See last pages for disclaimer. reason why the European recovery remains much more elusive than in the US. Estimated by the IMF, 3% additional fiscal support could lift GDP by 2% by the end of next year, as illustrated in Chart 17.
Why there is anything but enthusiasm among European finance ministers for such a push is difficult to understand. My bottom line is this: There is decent hope that Europe’s fiscal authorities will not start to withdraw fiscal stimulus already at this stage, as called for by a group of so-called Hanseatic states (which would almost certainly be a big policy mistake), but the hope for an extra push to get a full recovery into sight, e.g. by an extra 3% of GDP as suggested by the IMF, seems out of reach, unfortunately.
So, finally, question 7: Given the reality of the central forecast, the still elusive full recovery, the many remaining questions/uncertainties, against the virtual certainty that the US will continue to outperform Europe, how will markets impact financial conditions in the eurozone – and how will the ECB deal with it?
As you know, and as illustrated in Chart 18, so far, the FX market has remained amazingly stable with EUR/USD hovering around 1.20. The best one can say about that is that the euro appreciation which we (and some others) expected a couple of years ago hasn’t materialized. But we – and the ECB – are getting no actual help from the FX market in terms of a lower EUR/USD. Rather, instead of importing a weaker currency and hence some stimulus, the eurozone was importing higher yields from the US, and hence tighter financial conditions, for almost a year until some three months ago. As illustrated in Chart 19, the ECB did a great job compressing the European curves, but it’s equally clear that the PEPP was of utmost importance in this endeavor, as illustrated in Chart 19. (Note to the ECB: There is no amount of forward guidance that will make up for a reduced amount of PEPP purchases!)
And, importantly, as illustrated in Chart 20, luck – in the form of lower US yields since April – have played an important role too. Personally, I would assign a low probability to that sort of luck continuing for much longer. So, in conclusion, in my assessment, the ECB will be facing an uphill battle to deliver 2% inflation, given the continuous structural forces, the likely fiscal stance and its own reluctance to employ the truly powerful instruments, including yield curve control (underwritten by unlimited and flexible asset purchases) or even helicopter money. The divergence with the US, and the likely increase in upward pressure on yields from across the Atlantic, will make the task even harder. One thing is clear, it’s surely not the time to phase out the PEPP. Put differently, the ECB is being dealt a nearly impossible hand. They – and everyone else – should be more vocal in the call for appropriately sized, and well-designed, fiscal stimulus at least through 2022, and very likely into 2023 as well.