William De Vijlder

Group Chief Economist BNP Paribas

ECB: committed to ease in September, but how much?

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inflation definition

Eurozone: pockets of inflation in a low inflation world

Despite an increase in June, core inflation in the eurozone remains stubbornly low. The dispersion is significant between countries and between the expenditure components of the price index. Inflation is low for clothing and footwear, furnishings and household equipment, transport and communications. It is higher for housing-related items, restaurants and hotels, miscellaneous goods and services and recreation and culture. Non-energy industrial goods price inflation is very low. Should this continue, it would imply that the acceleration of inflation which is the ECB is pursuing by renewed policy easing, has to come from services. However, research shows that it takes more time for services prices to respond to monetary policy and economic activity. Monetary accomodation is here to stay.

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Growth concerns on the rise

A sigh of relief followed the publication of first quarter GDP data. However since, growth concerns have picked up again on the back of a collection of new economic data but also — and perhaps more importantly — due to continued high uncertainty. The latter stems from concerns over the extent of the slowdown and its consequences in terms of economic risks. It also emanates from escalating tensions between the US and China over trade. The effects of this confrontation already show up in the Chinese data while in the US, mounting anecdotal evidence also point to its detrimental impact on business and the agricultural sector. The Federal Reserve has turned a corner and indicated that rate cuts are coming, much to the joy of the equity market. The ECB has also changed its message: with risks tilted to the downside and inflation going nowhere, it considers more easing is necessary.

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full employment

Monetary easing at full employment: how effective?

Fed Chairman Powell, in his address to Congress this week, has confirmed that easing is coming. In June, ECB President Draghi provided similar hints. This comes on the back of growing concerns regarding global growth and ultimately facing too low a level of inflation. Risks may be mounting, but, on the other hand, the unemployment rate is close to the natural rate. There are reasons to assume that monetary easing under full employment would be less effective than when the economy is marred in recession. Monetary easing could also raise concerns about financial stability, which, if unaddressed, could weigh on the ability of monetary policy to successfully boost inflation.

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monetary policy

Exogenous versus endogenous uncertainty and monetary policy

A high level of uncertainty can act as a drag on growth. Whether monetary easing will succeed in boosting growth will depend on the nature of uncertainty. Endogenous uncertainty follows from the normal development of the business cycle and rate cuts should succeed in reducing this uncertainty by boosting confidence of economic agents. Exogenous uncertainty is not driven by the business cycle but is triggered by other factors, such as, in the current environment, ongoing trade disputes. In this case, monetary policy effectiveness suffers and, despite rate cuts, the growth slowdown should continue until its root cause (exogenous uncertainty) is addressed.

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William De Vijlder - EcoTV Week - July 2019

United States: Much reason to celebrate?

This week saw two reasons to celebrate in the US. First, it’s 4th of July week and, second, we have started the 121th month of economic expansion, the longest in US history. The former is obviously a festive event, but turning to the economy, is there still reason to celebrate?

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William De Vijlder June 2019

Soft landings are difficult, even more so today

The Fed has turned the corner and is now looking towards moving into easing mode. Low inflation makes this possible, slowing growth and significant external headwinds make it a necessity. However, the track record of successful soft landings is poor. In the current environment, the challenge is considerable given already low rates in a very mature expansion. The biggest issue however is uncertainty with respect to trade.

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ecnomic slowdown

France and Germany: Very different cyclical slowdowns

The slowdown since the start of last year is of a different nature in France, where it has manifested itself in manufacturing and services, compared to Germany, where it is very much concentrated in the manufacturing sector. Recent data show a somewhat improving picture in France whereas in Germany signs of stabilisation remain tentative. Under the hypothesis that concerns about trade relations (US-China, US-Europe) and Brexit will not disappear anytime soon, it seems difficult to expect a significant improvement in the near term. France could however surprise positively on the back of the measures to support the purchasing power of households.

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Central banks: synchronised swimming against the tide

ECB President Mario Draghi, speaking at Sintra, has raised expectations of renewed policy easing. The message from the FOMC meeting is that rate cuts are coming. This policy synchronisation reflects shared issues (inflation too low versus target) and shared concerns, the major being rising uncertainty. Should this continue, the effectiveness of monetary accomodation will suffer.

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US flags

US economy: on a slippery slope

Speaking before the Economic Club of New York recently, Richard Clarida, Vice-President of the Federal Reserve, drew a positive picture of the US economy. Over the past four quarters, real GDP growth has averaged 3.2%, while the unemployment rate verged on a 50-year low of 3.6%. Month after month, job creations are still going strong. The Federal Open Market Committee (FOMC) is projecting growth of about 2% for the next three years. Clearly, all seems to be going for the best in the best of all possible worlds.

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eurozone tagcloud2

Eurozone: when manufacturing sneezes, do services catch a cold?

According to Mario Draghi, a key question is how long the rest of the economy can remain insulated from the weakness in the manufacturing sector. Historically, the purchasing manager indices for manufacturing and services have been highly correlated, which can be partly attributed to the important role of services in the value chain of the manufacturing sector. The future resilience of the services sector in the eurozone will very much depend on what happens in Germany where the gap between the PMIs of the two sectors is abnormally high.

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ECB by night

ECB: getting ready for more easing, but not in a hurry

The ECB has eased policy slightly, by extending its forward guidance on policy rates. On the other hand, the conditions on TLTRO III are slightly less generous than those on the previous operation. Importantly, a discussion has started within the Governing Council on how to react should the environment worsen. Understandably, given the eurozone fundamentals, the ECB is not yet in a hurry to react to the prolonged uncertainties. This is a matter of keeping its powder dry.

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Does psychology dominate company fundamentals?

In a recent survey of 469 CFOs of US companies, 84% expect that the US will have entered recession by the first quarter of 2021. This raises the concern of self-realising bearish expectations. A positive correlation between business confidence and company decisions could reflect (anticipations of) strong fundamentals. It could also be due to animal spirits. The role of the latter is confirmed by empirical research by cesifo using data for German companies. In the aggregate, optimistic animal spirits have a bigger impact than pessimistic animal spirits.

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eurozone tagcloud2

Eurozone: Mixed signals

Survey data released this week provide mixed signals with an improvement of consumer confidence, a weakening of the ifo business climate index in Germany and a stabilisation of the INSEE indicator in France. The IHS Markit PMIs show a stabilisation in recent months in manufacturing, at a subdued to low level, and in services, at a more satisfactory level. Several drivers of domestic demand remain supportive. Nevertheless, unease remains, mainly for reasons on which the eurozone has no control and where the risk of further tariff increases is top of the list.

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William De Vijlder May 2019

Policy uncertainty creates forecast uncertainty

On the surface, the recently released forecasts of the IMF, the European Commission and the OECD look satisfactory, without being great. Upon closer inspection, unease dominates for a number of reasons: developments in emerging markets, China’s slowdown, slowing world trade growth and, above all, risks and uncertainties (protectionism, Brexit). OECD simulations of the impact on growth show the importance of avoiding that these risks materialise.

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US: The import tariff boomerang

Import tariffs have a negative impact on the targeted country. Retaliation will in turn have negative consequences for the country which started the tariff hikes. Even in the absence of retaliation, there will be negative consequences. Household spending will suffer from a loss of spending power due to an increase in inflation following higher import prices and/or a switch to domestically produced goods. For the same reason, aggregate corporate profits may suffer. Companies may also cut back their investment because of increased uncertainty. Empirical research confirms these outcomes.

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Europe: lower CO2 emissions from energy use

In the European Union, CO2 emissions from fossil fuel combustion declined 2.5% in 2018 compared to the year before. Considering that GDP grew, this implies a reduction in carbon intensity, thereby continuing a long-term trend. The developments in individual countries vary and quite a number of countries have seen an increase in emissions. Likewise, the differences are considerable concerning the emissions per capita depending on the level of economic development, although this is just one factor amongst many which influence the emission intensity.

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United States: Strong growth but questions about quality

According to Jerome Powell, the fundamentals supporting the US economy remain solid. First quarter growth has been robust but underlying concerns about the quality of growth have emerged. Growth has benefitted from a drop in imports and rising inventory levels while residential investment acted as a drag. In the coming months, imports should rebound and inventories should witness a scale back. The onus will fall on consumer spending and corporate investment to neutralise the effects of these anticipated headwinds on growth.

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public finance

Growth, interest rates and government debt

The relationships between government debt, economic growth and interest rates are complex and varied. In general, a recession causes an increase in government debt and a decline in government borrowing costs. A prolonged period of monetary accommodation during a cyclical upswing can cause the average nominal interest rate on government debt to drop below the rate of nominal GDP growth. Depending on the level of the primary balance, such a situation can, under certain conditions, create leeway for fiscal expansion in order to support growth.

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ECB: easing of inflation raises pressure

The pass-through of wage growth to prices is stronger and faster when inflation is higher to start with. The low inflation in the Eurozone has slowed down the transmission. The considerable growth slowdown, on the back of adverse foreign demand and uncertainty shocks, impairs this process even more. This raises pressure on the ECB to take action in order to dislodge core inflation, which remains stuck well below its objective.

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global economy

Lingering concerns despite hopeful signs

Recent data in China and the eurozone point towards a stabilisation of growth and have been met with relief. Although the US economy is slowing, growth should remain at a satisfactory level in the near term. Yet there are lingering concerns about the underlying strength of the global economy. The IMF has again scaled down its forecasts and only expects a modest growth pickup later this year. The flattening of the US yield curve fuels worries that growth will disappoint. The Fed insists it is confident about the outlook and patient in setting its policy. Markets have welcomed this accommodative message. Yet the signals sent by equity and bond markets about future growth are quite different. It only adds to the list of concerns.

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William De Vijlder

About William De Vijlder

Group Chief
BNP Paribas
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