Euro Bears Seeking Redemption in Inflation Slowdown: CurrenciesDavid Goodman
Long-suffering euro bears are gaining comfort from the lowest outlook for inflation since the depths of the financial crisis in 2008, putting pressure on policy makers to boost the supply of cheap money that would weaken the currency.
The five-year consumer-price swap tumbled 0.05 percentage point in the past week to 1.24 percent, compared with the European Central Bank’s inflation target of close to 2 percent. The last time price expectations declined that much was November, when policy makers went on to cut their main interest rate to a record, sending the euro to an almost two-month low.
“Given that inflation is likely to remain very low, we think the ECB will have to do more,” Michael Sneyd, a currency strategist at BNP Paribas SA in London, said in a phone interview yesterday. “Inflation is below 1 percent, so the ECB is seriously failing in its mandate. We’re very comfortable being short-euro.”
Disinflation, caused by stagnating consumer demand, saps growth and weakens the currency by reducing the appeal of euro-denominated assets. It’s more of a problem for the 18-nation euro area than other major economies such as the U.S. and Japan because the ECB has refrained from the aggressive monetary easing they’ve adopted, HSBC Holdings Plc said last month. As the central bank prepares for its monthly meeting in Frankfurt tomorrow, there’s speculation President Mario Draghi will follow his peers’ lead and either cut rates to near zero or announce alternative measures such as bond purchases.
Euro-area consumer prices rose 0.7 percent in January from a year earlier, matching the lowest level since November 2009 and falling short of the ECB’s target for a 12th month. Retail sales in the region unexpectedly fell, a report showed today, sliding 1 percent in the year to December after climbing 1.3 percent the previous month.
The euro is already suffering, falling 0.4 percent this year against a basket of nine developed-market peers, the biggest drop after the Canadian dollar and Norwegian krone, according to Bloomberg Correlation-Weighted Indexes. In 2013, the shared currency was the best performer, snapping four years of declines to strengthen 8.2 percent.
The euro slipped to $1.3477 on Feb. 3, the lowest level since November, after reaching a two-year high of $1.3893 on Dec. 27, and was at $1.3519 as of 12:31 p.m. in New York.
“We see inflation risks tilted to the downside, not balanced as the ECB observes, implying the possible need for a more accommodative policy later this year,” Andrew Bosomworth, the Munich-based managing director and head of portfolio management at Pacific Investment Management Co. LLC, wrote in a note today. “If the ECB would embark on an asset-purchase program, how much, and what, would it buy? We think the ECB would have to buy about 1 trillion euros ($1.4 trillion) worth of assets.”
BNP predicts the currency will decline to $1.23 by the end of 2014, making it among the most bearish forecasters in a Bloomberg survey of 63 strategists. The median estimate is for a decline to $1.28, which would mean the euro falling about 7 percent this year, its worst performance since 2005.
The prospect of disinflation turning into the deflation, or falling prices, which caused 15 years of stagnant Japanese growth, is unnerving officials in developed countries around the world. International Monetary Fund Managing Director Christine Lagarde urged authorities last month not to unleash the deflation “ogre.”
The ECB has warned investors about the threat that disinflation, or falling consumer-price inflation, poses to the economy. After October CPI was estimated at 0.7 percent, Draghi unexpectedly lowered the main interest rate by a quarter-point to 0.25 percent on Nov. 7, saying “the economic analysis indicates that we may experience a prolonged period of low inflation.” The euro fell that day to $1.3296, the lowest level since Sept. 16.
While the median forecast in a Bloomberg survey of 66 economists is for the ECB to keep its main rate unchanged tomorrow, Royal Bank of Scotland Group Plc, Danske Bank A/S and Barclays Plc predict a cut to 0.1 percent.
“The central bank can’t take too many risks around deflation because once it gets hold, it’s very hard to turn it around,” Paul Robson, a currency strategist at RBS in London, said in a phone interview yesterday. “You may well get a tweak in the policy rate this week to show the central bank is mindful of the risks.”
Another interest-rate cut would be a “small negative” for the euro and the ECB would need to show it’s prepared to use less conventional measures to cause the currency to weaken significantly, Robson said. RBS forecasts a decline to $1.27 by Dec. 31. BNP’s Sneyd said the bank expects policy makers to start buying government bonds in the second half of 2014.
Last year, the euro strengthened 4.2 percent versus the dollar even after the ECB cut rates twice. The currency’s gains defied the median prediction of strategists surveyed by Bloomberg, who foresaw a drop to $1.27, from $1.3193 at the end of 2012.
“Positions have been trimmed quite a lot already, although that trimming has been abated to a certain extent,” Nick Beecroft, the London-based chairman and senior market analyst at Saxo Capital Markets U.K. Ltd., which forecasts the euro will weaken to $1.18 this year, said by phone yesterday. “Inflation and the transmission of money isn’t getting any better. I’m seeing euro-dollar lower.”
The five-year consumer-price swap allows investors to receive floating-rate payments linked to inflation and make fixed-rate payments in return. The measure of price expectations is the lowest on a closing-price basis since December 2008, and has fallen from 1.84 percent on Jan. 8, 2013.
The German 10-year break-even rate, a measure of inflation expectations derived from the yield difference between conventional bonds and index-linked securities, was at 1.38 percentage points, the lowest since May 2012 based on closing prices and down from 1.55 at the end of last year. The equivalent U.S. rate has fallen to an almost two-month low of 2.13 percentage points, from 2.3 percent on Jan. 9.
The euro-region economy grew 0.1 percent in the third quarter of 2013, while gross domestic product is forecast this year to expand 1 percent, compared with 2.8 percent for the U.S., according to economists surveyed by Bloomberg.
Disinflation detracts from the euro’s appeal as a haven from the turmoil in developing economies, according to Morgan Stanley, which sees the currency falling to $1.24 this year.
“There are both internal and external pressures which are going to keep the disinflationary or deflationary theme very much in place,” Ian Stannard, the London-based head of European currency strategy at the U.S. bank, said in a Feb. 3 phone interview. “This will likely lead to the ECB having to take further action. We think the euro is looking increasingly vulnerable.”