Deflation risk starts debate over ECB mandate
There are no fundamental grounds in the European Central Bank's 'first pillar' of policy analysis for not easng tomorrow in rapid reaction to the rising external currency value. The debate over the dangers of deflation - starting in Germany but not stopping there - was resurging even before the jump in euro/dollar yesterday to 1.1449. Thus clients should not totally rule out a rate cut even if a quick move now is less probable than a 50bp cut on June 5.
A Bundesbank seminar last week showed that the German economic community is beginning to think the unthinkable - that a single, low-inflation objective may not be a sufficient mandate for a modern monetary authority. Germany is looking toward the Japanese experience with increasing concern.
This debate is reflected to some extent inside the ECB. Alterations to its strategy, probably announced later in May03, are likely to include a higher floor of 1%y/y for the headline inflation target range, and a greater stress on monitoring credit behaviour alongside the referencing of broad money. Latest euro M3 data show the widest-ever recorded gap with the ECB's 4.5% money growth reference, but an unaltered nominal M3 expansion at 7.9%y/y.
SummaryAsset conclusions: Rapid fall of 10yr euro sovereign yields to 4% today is precursor of further curve move lower a currency soars; 3.5% in sight now.
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© Graham Bishop
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