The ECB changes its tune on inflation

Last Thursday, the Bank of England decided to raise its base rate to 0.50%. The decision comes after a previous hike in December from 0.10% to 0.25%. While the BoE aims to keep inflation at around 2%, prices had jumped 5.4% by the end of last year. And as energy prices soar, the central bank is expecting the prices to see an annual increase of 7.25% in April. As the vote on monetary policy shows, BoE members appear divided on the pace of monetary tightening: half (four out of nine) favour a faster approach via a half-point hike instead of a quarter-point. The more hawkish ones want to send a strong message to temper expectations of persistently high inflation that would affect wages. The others, more dovish, feel that tightening monetary policy too quickly as anticipated by the market would weigh heavily on the ongoing recovery.

Also last Thursday, the European Central Bank left its monetary policy unchanged as expected. Ultimately, however, the ECB has changed its tune in the face of continuing high inflation. In her comments, Christine Lagarde underlined that the risks posed by inflation are clearly on the rise. Everything is now on the table for 2022: the ECB is no longer ruling out rates hikes as early as this year, although this scenario was not mentioned until now. Prices have seen significant increases in the eurozone, with annual inflation hitting 5.1% in January, even as the consensus was 4.4%. Therefore, inflation is still going strong and following the same (annualised) pace as in November and December.

Following the ECB statements on Thursday, the euro-dollar pair jumped two cents: from 1.1280, it quickly broke 1.14 and then continued to appreciate to 1.1484 on Friday. Against the Swiss franc, the euro broke through the 1.06 mark before consolidating. Bond yields in Europe also jumped. Since the beginning of the month, the French 10-year rate has risen from 0.43% to 0.73%, the Bund has increased from 0% to 0.27% and the Gilt from 1.3% to 1.5%. At the same time, the US 10-year Treasury yield has risen from 1.78% to 1.96%.

Bond yields and the single currency have subsequently fallen slightly in the last few hours, possibly due to the ECB’s President’s new statement to the European Parliament: likely wishing to play for time before a possible hike in the first half of the year, Ms Lagarde said that there is ‘no need to rush to any premature conclusions at this point’. She also stressed that rate hikes would come gradually, only after asset purchases had stopped. The President of the Banque de France also felt that the market had overreacted to the ECB’s more hawkish tone.

In Germany, industrial production unexpectedly fell by 0.3% in December, whereas a rise of 0.4% had been expected. The construction sector was particularly affected by supply and labour shortages and closures during the holiday season. Over the last year, the German economy grew by 2.8%. For reference, France and Italy saw 7% and 6.5% growth, respectively, over the same period. This gap is primarily explained by the industrial sector’s preponderance in the German economy, which renders it particularly vulnerable to global supply chain and procurement difficulties.

In the US over the last year, the goods and services deficit reached $859 billion, and the goods deficit reached $1.09 trillion. Both are all-time highs. Logically, the trade balance deficit increased by 27% last year. As economies have reopened, exports have rebounded strongly but less than imports, boosted by strong domestic demand supported by government subsidies. Tomorrow we will be looking at consumer price figures. The market will interpret the figures as it wonders whether the Fed will raise rates by 25 or 50 basis points at its next meeting in March.

This morning US oil traded around $89 a barrel after hitting a seven-year high of $92.31. This slight downturn has come as a result of progress in the Iranian nuclear issue and French President Emmanuel Macron’s diplomatic visit to Vladimir Putin. Lastly, the price of aluminium is at an all-time high of $3,200 due to supply difficulties: low stocks and shortages in China and abroad.