Euro Inflation Set to Fall More than ECB Thinks
Euro area inflation set to fall as further strengthening of euro/dollar cuts import prices, boosts bonds
It is absurd for the European Central Bank to maintain, as it did most recently in its May03 monthly bulletin last week, that there are no indications for further strong falls in inflation in the near future. The lessons of 1985/86 for west Germany show that the transmission strength of a sharp external exchange rate appreciation into consumer prices far outweighs domestic events such as above-inflation nominal wage growth.
The argument that the currency move is less important since the euro area is less dependent on external trade than west Germany was also does not hold water: the tradable sector is not necessarily smaller.
The euro appreciation plus the world economy weakness will have just as powerful an impact on inflation soon. The starting point for CPI is about the same as Germany in 1985, euro area unemployment is higher and wages are more subdued. We think euro/dollar will rise to around 1.25, equivalent to DM/dollar 1.56. If we are right, the ECB minimum bid rates should drop another 100bp. The probability of a cut on June 5, and of it being 50bp, are both around 70%, in our view. This is the second of a two part report (EZA rpt 531/03May22)
SummaryAsset conclusions: Falling inflation to be deeper than ECB thinks; euro bond yields to be supported by possibly another 100bp in short rate falls
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© Graham Bishop
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