The Sintra “Nothingburger”

By Elwin de Groot, Head of Macro Strategy at Rabobank

Inflation data from the German state of North-Rhine-Westphalia (NRW), out this morning, injected fresh concerns that the battle of getting inflation down in the Eurozone is still very much on. Headline inflation accelerated 0.5pts to 6.2% y/y in June. Higher energy inflation was one factor, but the other more concerning issue was renewed upward pressure on core inflation, as this was up 0.6pts to 5.6% in Germany’s most populous state. Services inflation even accelerated 0.9pts to 4.8% y/y. Within those two latter categories, though, the picture was quite mixed and so these data do not necessarily signal another broad-based pickup in underlying inflation. More data this morning should confirm whether this sharp rise in NRW was a regional outlier or not.

Spanish inflation eased to 1.6% in June from 2.9% in May (its much lower level compared to other EZ member states is largely a reflection of a much sharper decline in energy prices since mid-2022, due to different policy choices, such as energy price caps), but core inflation did not fall as sharply as expected: it eased just 0.2pts to 5.9%. These data followed more subdued readings published yesterday in Italy, where the inflation rate fell 1.3pts to 6.7%. That was even a tad lower than the consensus forecast and, as such, good news, especially after last month, when the inflation figure disappointed. This can be explained from base effects, as the y/y change in energy prices was still positive in Italy, whilst it was negative in most other EZ countries. It was thus to be expected that the Italian inflation figures would fall as base effects for the energy prices materialize in Italy.

On balance, the inflation data from Eurozone member states underscores that the inflation slowdown trajectory in the coming months will likely remain wobbly, to say the least.

That also means that the ECB – which is now in a ‘data-dependent’ mode and hence, more inclined to look in the rear-view mirror rather than in its crystal ball which has failed it so often – will have little choice than ‘not to waver’ on its inflation crusade, as ECB President Lagarde emphasized in her Keynote speech earlier this week at the Sintra conference. To ensure that this uncertainty does not interfere with its intended policy stance – in terms of both level and length – she argued that the ECB i) needs to bring rates into sufficiently restrictive territory, and ii) needs to be clear in its communication that rates will stay at those levels for as long as necessary.

Obviously with the ECB’s forum in Sintra still going on; there was the potential for some more action. But, despite having a panel with a stellar cast of Powell, Lagarde, Bailey and Ueda, and a moderator that was really looking for some juice, we didn’t really get any fresh policy signals and it was all a bit of a nothingburger.

Let’s do quick rundown. Lagarde said she is not seeing enough proof core inflation is coming down, and despite leading indicators of growth pointing lower, the ECB focuses exclusively on its 2% policy target. The BoE’s Bailey said that UK core inflation is much stickier than expected, and paraphrasing his comments on market pricing of future Bank rate, we’d say he went for “less high, but much longer”… so that would put Bank rate in the high 5s for longer than a 6%+ rate followed by quick cuts. The Fed’s Powell hasn’t seen much progress in non-housing services inflation yet, and confirmed that most Fed officials were looking for at least 50 bps this year because of stronger growth, a resilient labor market, and persistent inflation.

So that supports the view that even though there is still some tightening in the pipeline, in the UK in particular, there will be an increasing emphasis on the time dimension of monetary policy. The bottom line is that in the US, the Eurozone and the UK, policy hasn’t been restrictive enough for long enough to see a real impact on core inflation.

The BoJ’s Ueda, in his turn, said that underlying inflation remains below target in Japan and that the BoJ will only reconsider negative rates and YCC when they are confident that inflation will re-accelerate in 2024. That sharp contrast between Ueda and his peers has been a key source of yen weakness of late, with USD/JPY pushing to 144.65 this morning, the weakest level for the yen since November last year. Early this week, Japan’s top currency official, Masato Kanda, said he “wouldn’t rule out any options to handle currency matters appropriately”, which is a euphemism for intervention. Kanda repeated his warnings yesterday. But as long as the BoJ sticks to its “steady” stance whilst other central banks are taking out more inflation insurance, such intervention may prove costly and ineffective.

However, for those that are still putting some value on forward looking indicators, the ECB money supply and credit data, out yesterday, made for some interesting stuff. Overall, it lent further support to the view that monetary tightening is increasingly weighing on the provision of credit and is contributing to a slowdown in broad money. Growth of credit to the private sector slowed to 2.1% y/y in May, down from 2.4% in April. Loans transaction data showed a slight increase in new credit to non-financial corporations in May, but this was more than offset by a sharper decline in new loans to households; in fact the latter showed a slight decline in net new loans (in other words, redemptions exceeding gross loan production at banks). It was the first time since April 2020 that household net loans provision fell. According to our calculations, the Eurozone non-financial private sector credit impulse indicator fell to -2.4% y/y from -1.3% in May. This was the third consecutive month of a negative reading and implies that credit is now ‘contributing’ to declining growth. That doesn’t necessarily mean that investment spending will fall off a cliff as profit margins at firms would still allow them to keep investing, but at the margin it is pointing at future weakness in growth.

As credit growth has been slowing and excess liquidity is declining on the back of TLTRO repayments and a gradual unwind of the ECB’s bond portfolio, it is no surprise that the liability side of the European banking sector is also showing a further fall in growth of broad liquidity. The M3 growth rate fell to 1.4% y/y from 1.9% in April. The more liquid M1 measure, which comprises currency in circulation and overnight deposits, fell to -4.7% y/y. This is the sharpest contraction in M1 since, at least, the 1960s. It reflects a shift out of the most liquid components as a result of (still) relatively low rates on current accounts, but also means that more money is being locked up in term deposits or securities instead of being available to support spending.