Market Economics | Interest Rate Strategy - BNP PARIBAS ...

The modest deviation of inflation currently relative to
the ECB’s definition of price stability was a point
emphasised in an interview with Governing Council
member Orphanides on 14 January, the day after the
‘hawkish’ press conference. He also hinted, as others
have, that the market may have over-reacted to the
comments in the press conference.
…but there are risks
There are three potential challenges to our view of no
rate hike this year. First, that commodity prices
remain higher for longer, outweighing the favourable
base effects pushing down on headline inflation from
the spring. If, as a result, inflation were to stay higher
for longer, this would increase the risk of upward
pressure on wages and inflation expectations. The
‘emergency’ level of rates would be increasingly
inappropriate in this context.
In those circumstances, economic growth prospects
would suffer. Commodity price rises would crimp real
income growth for households and ECB rate hikes
would hit confidence. This would probably limit how
far the ECB tightening cycle would go.
Box 2: Extracts from ECB Monthly Bulletin
“Labour cost indicators for Q3 2010 continued to show
subdued wage pressures. Preliminary information on
negotiated wages for the first month of Q4 suggests that
the pattern of moderate wage growth continued… in line
with continuously weak labour market conditions.
The annual rate of growth in euro area negotiated wages
slowed to 1.4% in Q3 2010, a record low since the start
of the series in 1991. Annual hourly labour cost growth in
the euro area also slowed in Q3, to 0.8% from 1.6% in
Q2. This too is the lowest growth rate observed since
the start of this series in 2001.
The annual growth rate of compensation per employee
slowed to 1.5% in Q3 from 1.9% in Q2. This decline was,
with a few exceptions, broad-based across countries.
Sectoral developments show that the deceleration in the
annual rate of change in the labour cost index in Q3
2010 was broad-based across sectors.”
Monthly Bulletin, January 2011
Source: ECB
Chart 4: Real Policy Rates
The second risk to our forecast of unchanged rates
this year is that pay pressures emerge in the core
countries of the eurozone, most likely in Germany,
prompting an ECB response. A recurring theme of
our analysis for some while now has been to expect
a pick up in wage growth in Germany. This reflects
the obvious factors including: the low unemployment
rate; skill shortages in some fast-growing sectors;
and looser policy than for German needs.
3.5
3.0
2.5
2.0
1.5
1.0
0.5
0.0
-0.5
Refi Rate
As conditions in peripheral countries will be radically
different, assessing how the Governing Council will
respond to ‘local’ pay pressures is difficult to judge. If
it is a problem for Germany only, it may be difficult to
secure a consensus on the Governing Council in
favour of hiking rates. But at the very least, we can
expect the vocal hawks on the Governing Council to
make a lot of noise about the upside risks to inflation
and the need for a policy response.
Normalisation mode
An alternative scenario of earlier rate increases than
we currently expect is via the ‘normalisation’ route. In
short, the rationale would be that the level of policy
rates has been set at an emergency level but the
emergency is over – for the eurozone as a whole if
not for specific member states. In this context, there
is a case for taking rates higher whether secondround
effects start to appear or not.
The level of policy rates in real terms is unusually low
(Chart 4). Measured on the basis of the headline
inflation rate or inflation expectations, real short-term
rates are well below zero. Measured on the basis of
-1.0
-1.5
Relative to HICP (% y/y)
EONIA
99 00 01 02 03 04 05 06 07 08 09 10
Source: Reuters EcoWin Pro
7
6
5
4
3
2
1
0
-1
-2
-3
-4
-5
-6
Chart 5: Nominal Growth & Policy
99 00 01 02 03 04 05 06 07 08 09 10 11 12 13
Source: Reuters EcoWin Pro
Real GDP (% y/y) + HICP (% y/y)
ECB Refi Rate (%)
BNPP Forecast
core HICP inflation, real policy rates are negative still
but less dramatically so.
Ken Wattret 20 January 2011
Market Mover
20
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