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Silvia Quandt & Cie. AG, Merchant & Investment Banking: In-between the lines – Bernhard Eschweiler
Silvia Quandt & Cie. AG, Merchant & Investment Banking / Schlagwort(e): Sonstiges/Sonstiges – Euro debt crisis overshadows start into 2012 but something has changed – Global growth and monetary policy conditions have improved – Falling Euro-area inflation to give ECB room for more rate cuts Financial markets started the New Year the same way they finished the Old Year. The Euro-area debt crisis continues to dominate market sentiment. Nevertheless, a few things have changed. – First, political leaders, foremost Germany’s Angela Merkel, no longer let themselves be pushed by markets. They are comfortable that the Euro system is not about to collapse and use the time to push for more fiscal and structural reforms. Latest bond auctions show a positive market response. – Second, global leading indicators have improved toward year end. Global business confidence is moving back into expansion mode, led by the US. The Euro area remains the weak link, but is no longer in a free fall. – Third, monetary policy makers are doing more for growth. Most prominent have been the rate cuts and liquidity injections by the ECB at the end of last year. The ECB is now taking a break to watch the impact, but will probably do more toward spring. The US Fed, although under less pressure, is making sure that interest rate expectations will stay low for a long time. In emerging markets, China is leading the easing cycle. A second cut in reserve requirements is likely to follow soon and new loans are already showing signs of revival. To be sure, uncertainties will remain high. Tensions are likely to increase as troubled Euro-area sovereigns try to refinance record sums of maturing debt in the first quarter, while banks are struggling to find new capital. Nevertheless, we feel encouraged by the policy and global cyclical changes. Especially Germany should do better in this environment, which is why we are sticking to our 1.5% growth forecast for 2012. Domestic slack to push Euro-area inflation down A key justification for the ECB rate cuts and liquidity injections late last year is the view that the economic downturn in the Euro zone will have disinflationary implications. The argument makes economic sense and shows that the ECB under President Draghi has learned something from the Bundesbank. Nevertheless, that forecast needs to turn into reality. If not, the ECB will lose credibility, which would reduce its flexibility to set policy on forward-looking growth and inflation projections. Inflation is a lagging indicator. Nevertheless, with headline inflation well above the target level, the ECB must have a lot of confidence in its forecast. Thus, the decline in headline inflation to 2.8% in December from 3% in November was welcome news. Still, it is some way for inflation to drop to the 2% target in 2012 and even below the target in 2013 as the ECB central forecast implies. Favorable base effects – large price increases early last year dropping out of the over-a-year-ago rate – will push headline inflation further down in coming months. The ECB expects external price pressures, especially from commodity markets, to ease this year and help bring inflation lower. Indeed, global inflation conditions have improved significantly, especially in emerging markets, such as China. In our judgment, global inflation will drop from around 5% in 2011 to below 4% in 2012. However, we are less optimistic that commodity prices will soften much. Already, oil prices are responding to signs of stronger economic activity. Especially a pick-up in China will accelerate this trend. Instead, we expect that the main contribution to disinflation in the Euro zone will come from the slack in the domestic economy. Depending on the estimates, Euro-area output is between 2% and 4% below potential. This is also reflected in well below normal capacity utilization rates. Add to this the prospect of further weakness and it becomes clear that economic slack will increase. This is visible in unemployment and starts to translate in falling unit labor cost, which will be the main source of disinflation. Finally, there is no risk for inflation from monetary developments despite the massive expansion of the ECB balance sheet. Money supply growth eased again toward year end and is close to previous lows. The same is true for credit to companies and private households. The sluggish development of monetary aggregates shows that the main task remains avoiding deflation and not fighting inflation. From the perfect storm to crosswinds After a sequence of negative news that became a perfect storm in mid 2011, financial markets are likely to be pushed between two opposing forces this year. In our judgment, the Euro will not break, but the uncertainty over its future will remain elevated through at least the first half of this year. On the other hand, signs of further improvements in global economic activity accompanied by super easy monetary policy conditions in the major OECD economies and many emerging markets will not pass financial markets unnoticed. The result could be less synchronization between different financial markets. The US is likely to do best, followed by some emerging markets, while the Euro area is set to be held back. Within the Euro area, Germany has the chance to outperform as it is fundamentally strongest and best positioned to benefit from the positive global economic and policy developments. Besides the Euro area slipping into bigger turmoil, the main risks are: fiscal policy confusion in the US in the run-up to the presidential election, slippage in one of the major emerging markets – China, India or Brazil – and geopolitical tensions, possibly triggered by Iran, Syria or North Korea.
Disclaimer This analysis was prepared by Bernhard Eschweiler, Senior Economic Advisor, and was first published 13 January 2012, Silvia Quandt Research GmbH, Grüneburgweg 18, 60322 Frankfurt is responsible for its preparation. German Regulatory Authority: Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin), Graurheindorfer Str. 108, 53117 Bonn and Lurgiallee 12, 60439 Frankfurt. Publication according to article 5 (4) no. 3 of the German Regulation concerning the analysis of financial instruments (Finanzanalyseverordnung):
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