ECB still accommodative, Japanese inflation remains sluggish

Macro Highlights - 6/8/2017

Economic activity in the eurozone continues to strengthen, but the lack of inflationary pressure should convince the ECB to keep its monetary policy unchanged, as M. Draghi suggested this week. The ECB should change little in its 8 June statement. In the months ahead, keeping its interest rates at a low level should bring the ECB to limit upward pressures on the euro and to steepen the yield curves. Japanese inflation has not picked up, because wage growth is low. Accordingly, the BoJ should keep its monetary policy unchanged for an extended period, even if its effectiveness is low.

The eurozone continues to send out positive signals. Data published this past week show that economic activity has strengthened further.

The Manufacturing PMI for the eurozone was at 57.0 in May, after coming in at 56.7 in April. The May figure is the highest since April 2011 and it suggests that growth should gain momentum in this sector. The Services PMI – which edged down from 56.4 in April to 56.3 in May – shows that growth is holding steady at a high level.

The European Commission's Economic Sentiment Indicator, which aggregates business and consumer survey results, edged downward from 109.7 in April to 109.2 in May. This is still its second-highest level since October 2007.

And the signs of improvement were not limited to confidence surveys. Unemployment dropped from 9.4% in March (preliminary figure: 9.5%) to 9.3% in April, which is the lowest it has been since March 2009.

Eurozone lending also continued to rise, as year-on-year growth in loans to non-financial corporations went from 2.3% to 2.4% in April (a level last seen in June 2009), while growth in loans to households stabalized at 2.4% (its highest level since April 2009).

M. Draghi acknowledged the eurozone’s improving economic data on 29 May at a hearing of the Committee on Economic and Monetary Affairs of the European Parliament. The ECB president stated that the recovery looks increasingly solid and that the extreme risks faced by the eurozone at the end of 2016 have sharply abated.


 Yet, M. Draghi has not changed his dovish tone. After noting that the ECB would weigh up the risks to growth and inflation at its next meeting – as the ECB’s quarterly staff projections will be available – he suggested that there would be no major changes in the ECB’s monetary policy or stance. He told: “we remain firmly convinced that an extraordinary amount of monetary policy support, including through our forward guidance, is still necessary.”

Expectations that the ECB would not change its monetary policy strengthened after the release of the preliminary eurozone inflation figures for May. Headline inflation declined by more than consensus estimates, falling from 1.9% to 1.5%, while core inflation dropped from 1.2% to 0.9%, which was its average level in 2016 and in the first four months of 2017.

With the ECB set to meet on 8 June, investors should be reassured that the central bank’s accommodative measures should remain in place. The markets little reacted when the five main political parties in Italy agreed on a proportional electoral system and called to move Italy’s parliamentary election up from May 2018 to autumn 2017. Although the spread between Italian and German 10-year bonds widened this past week from 177 to 192 basis points, it is still below its 13 April 2017 level of 213bp. Furthermore, risk aversion in the eurozone did not rise sharply on this news. For example, the VSTOXX index, which measures implied volatility on the Eurostoxx, stood at 13.33 on 2 June versus 13.85 one week earlier.

Analysis and implications:

  • Following M. Draghi’s recent comments and the low core inflation reading in May, which was in line with our forecast, we are still convinced that the ECB should make only minor changes to its statement following its 8 June meeting.

  • The ECB staff projections for 2017-2019 could include an upward revision to GDP growth forecasts, but the inflation forecast should not change.

  • As regards risks to growth, the ECB may now see them more balanced and no more tilted to the downside.

  • Given these factors, the ECB could change its forward guidance, saying that it will keep key interest rates at current levels for a period extending well beyond the end of its asset purchase programme (while dropping the indication that it could lower rates further).

  • We still expect the ECB to wait at least until the second half of 2017 to announce plans to slow its asset purchase programme, and that no change would take effect before 2018.

  • We do not think the ECB will begin hiking its key interest rates for at least a few more quarters. This should limit upward pressure on the euro and help steepen eurozone yield curves.

  • In Italy, snap parliamentary elections could take place but would first require the president, Sergio Mattarella, to agree to dissolve parliament. If that happens, we expect market volatility to increase occasionally on fears of renewed political risk. But uncertainty surrounding the impact of the Italian elections on the eurozone should be limited by prospects of a growing French-German alliance following Emmanuel Macron’s election and with ongoing and likely future structural progress in the eurozone.

In Japan, inflation figures showed that prices continue to stagnate. Consumer prices ticked up 0.2% year on year in March and 0.4% in April. But this slim increase was driven mainly by the more volatile components of the index: excluding fresh food, inflation drops to 0.2% in March and 0.3% in April, while excluding fresh food and energy, inflation falls to -0.1% in March and no change in April.


 The absence of inflationary pressure despite the country’s economic recovery can be attributed to soft wage growth. That said, unemployment stood at 2.8% in April, its lowest level since 1994. Wage inelasticity in the face of a healthy job market reflects wariness on the part of Japanese companies, which are not keen to expand payrolls during the cyclical recovery given the country’s low level of potential GDP growth.

Analysis and implications:

  • Turning around sluggish wage growth in Japan, which is keeping inflation at a low level, will require structural reforms aimed at boosting productivity and, consequently, potential growth.

  • But until such measures are enacted, the BoJ is likely to have to keep its monetary policy very loose, even though its measures are poorly effective.

  • As a result, we expect the BoJ's accommodative monetary policy to remain unchanged in the next few months, and that this policy should stay in place longer than those of the other major central banks.


Sophie Casanova, Economist, Central Banks