Friday, November 15, 2013

Deflationary risks rising in the Eurozone; time for LTRO redux?

The euro area may be facing renewed deflationary pressures. Inflation measures are now near multi-year lows and falling.


The area's already uneven economic recovery has stalled in a number of countries. We've seen the French GDP growth dip into the red again (see Twitter chart). The employment situation in France also remains shaky.

French payrolls (source: Tradingeconomics)

Similarly, growth in broad monetary aggregates (M3 money stock) has turned lower. This has been driven by tight credit conditions (some of which is due to poor demand), with loan growth remaining extraordinarily weak (see discussion).

Source: ECB

Perhaps the most alarming indicator that may give Mario Draghi nightmares is the German housing index. German economic conditions remain quite stable as the nation continues to show strong export growth (see discussion). Nevertheless the German housing market is exhibiting signs of a correction (chart below). Bundesbank has been warning that the nation's housing market may be overvalued - so a correction may indeed be in order. But based on the experiences in Japan and the US, a sharp housing correction from bubble levels could quickly ignite deflationary pressures.


Some are attributing these risks to the fact that the ECB (Eurosystem) balance sheet has seen a massive decline this year. While this is a positive development since it was caused by the area's banks repaying MRO and LTRO obligations, some view the reduction in the size of the central bank balance sheet as a form of monetary policy tightening.

Putting together the data discussed above would suggest that the ECB will be moving toward another non-traditional monetary policy action. With the overnight rate near zero (25bp), there is little room for lowering rates further. Setting the rate on excess reserves to negative could be one option. But a more likely outcome is another longer dated LTRO program (see discussion) or even a new securities purchases initiative (Fed-style QE). While the effectiveness of another nontraditional monetary easing program could be debated, the ECB may soon be running out of options.
From our sponsor:
Related Posts Plugin for WordPress, Blogger...
Bookmark this post:
Share on StockTwits