Ebbing Inflation Means More Easy Money
Slowing inflation is giving central bankers scope to provide the world economy with more liquidity and lower interest rates for longer, all in the name of price stability.
European Central Bank President Mario Draghi may cut his benchmark rate to a record low as soon as this week as ebbing price pressures let him deliver more stimulus to the euro area’s recession-riddled economy. Federal Reserve Chairman Ben S. Bernanke at a policy meeting that starts tomorrow might have more room to press on with asset purchases as the argument against that strategy is undercut by waning inflation risks. Their counterparts from New Zealand to Canada also have more reason to keep policy loose.
The odds of disinflation are mounting as the world economy slows anew and commodity prices slide, defying forecasts that easy money would trigger an acceleration of prices. More than half of the world economy, including the U.S. and the euro area, instead confronts inflation below the central banks’ desired levels, according to Ethan Harris, co-head of global economics research at Bank of America Corp. in New York.
“There is a developing inflation problem: undesirably low inflation,” said Harris, a former Federal Reserve Bank of New York economist. “For central banks, this increases the pressure to maintain super-easy monetary policy.”
Declining prices for everything from gasoline to coffee are good news for consumers. The danger comes when disinflation turns into deflation, which leads households to hold off purchases in anticipation of even lower prices, and companies to postpone investment and hiring as demand for their products dries up and profits drop.
In Japan, which has suffered falling prices in 11 of the last 14 years, the new Bank of Japan Governor Haruhiko Kuroda this month announced a doubling of monthly bond purchases in a bid to reach 2 percent inflation in two years and revive the world’s third-largest economy.
The central bank largesse is buoying world stock markets, led by Japan’s, where the Nikkei 225 (NKY) average is up 12 percent this month. Even with signs of tepid expansion, the MSCI World Index has risen 8.9 percent in 2013.
“We’re not seeing the end of the road at all” to central bank efforts to boost growth, said Elizabeth Corley, chief executive officer of Allianz Global Investors, which manages more than 300 billion euros ($390 billion).
That means “there is this element of having some policy support for going into riskier assets,” she added, in an April 24 interview on Bloomberg Television’s “Market Makers.” She mentioned “high-quality equities,” particularly in Europe, as an attractive place to invest.
“The intensity of central bank reflation” argues that investors should overweight equities and underweight bonds in their portfolios, Bank of America chief investment strategist Michael Hartnett and his colleagues wrote in an April 25 report.
Government bond yields worldwide are at record lows of about 1.3 percent, according to Bank of America Merrill Lynch’s Global Broad Market Sovereign Plus Index.
Behind the receding inflation pressures: continued slack that led the International Monetary Fund to cut its forecast for global economic growth this year to 3.3 percent from 3.5 percent. Tighter fiscal policy is starting to squeeze the U.S., while the euro area is feeling the economic fallout of its debt crisis amid 12 percent unemployment. China may be shifting to a lower-growth gear after having expanded 7.8 percent in 2012, the weakest in 13 years.
Inflationary forces are further abating in the wake of this month’s collapse in the price of commodities from oil to copper. Julian Callow, chief international economist at Barclays Plc in London, estimates that what he calls the commodity price “tax” will be about zero this year, after having been responsible for 1.3 percentage points of the Group of Seven’s average inflation rate in 2011.
“Given the outlook for the global economy it’s hard to see how this commodity super-cycle” of rising prices “can continue,” John Lipsky, former first deputy managing director at the IMF and now a professor at John Hopkins University, told Bloomberg Television’s Sara Eisen on April 19.
The result is that worldwide inflation may fall to 2 percent in the second half of 2013, the lowest level since 2009 and down from more than 3 percent at the start of 2012, according to calculations by David Hensley, director of global economic coordination at JPMorgan Chase & Co. in New York.
McDonald’s Corp. (MCD) is among companies feeling a profit pinch because they’re unable to raise prices. The world’s largest restaurant chain by sales posted first-quarter earnings that were little changed from a year ago.
“Consumers are very sensitive to price,” Don Thompson, chief executive officer of the Oak Brook, Illinois-based company, said on an April 19 conference call. “We don’t have the inflationary environment or consumer sentiment environment to go out and take the same kind of price increases that historically we did.”
In another sign that businesses lack power to raise prices, automobile discounts in Germany climbed to their highest level in seven years in April, according to a monthly index by the Center for Automotive Research at the University of Duisburg- Essen.
“At the moment, nothing points to an easing of the discount situation,” said Ferdinand Dudenhoeffer, the center’s director.
Draghi’s ECB enters the spotlight May 2, a month after he declared the central bank stood ready to act if the economy deteriorated.
He acknowledged April 19 that the data haven’t improved. Reports today showed Germany’s inflation rate slumped to the lowest in more than 2 1/2 years in April and executive and consumer sentiment in the 17-nation euro-area decreased more than economists forecast.
Such faltering suggests the recession that began in the last quarter of 2011 may now extend into the second half of this year, when the ECB was previously looking for a recovery. A probable result is lower inflation, which at 1.7 percent in March is already undershooting the ECB’s target of just below 2 percent. The inflation rate fell to 1.6 percent in April, the lowest since August 2010, according to the median of economists surveyed before a report tomorrow, and the ECB projects it will sink to about 1.3 percent next year.
The decay last week led Barclays, JPMorgan and UBS AG among others to switch stance and predict the ECB will cut its key rate this week by 25 basis points from 0.75 percent. That would be enough to weaken the euro to as low as $1.28 from $1.30 at the end of last week, according to UBS.
Policy makers are sounding an alert. “Inflation is going down in a significant way,” ECB Vice President Vitor Constancio said on April 24.
Lower rates would make it cheaper for banks to borrow from the ECB, ensuring ample liquidity remains in the financial system, and help curb the cost of mortgages and other loans tied to the benchmark, said Richard Barwell, senior European economist at Royal Bank of Scotland Group Plc in London.
Still, their potency is limited, according to Societe Generale SA economist Anatoli Annenkov in London. Banks in crisis economies such as Spain are already reluctant to lend to businesses and another interest-rate cut may squeeze their profit margins further.
Unblocking lending may eventually require the ECB to lend more or lower collateral requirements for banks and unite with governments to establish loan programs for small and medium- sized companies, said Reinhard Cluse, an economist at UBS in London.
In the U.S., two regional Fed presidents -- Narayana Kocherlakota of Minneapolis and James Bullard of St. Louis -- voiced concern this month that inflation may be skidding far below the central bank’s 2 percent goal.
“We should defend the inflation target from the low side,” Bullard told reporters on April 17 in New York.
Consumer prices rose 1 percent in March from a year earlier, according to the Fed’s preferred gauge of inflation which was released today. That’s the smallest gain since October 2009.
Bernanke and other Fed officials have shown intolerance for very low inflation in the past. Not only does it raise borrowing costs in inflation-adjusted terms, it also could cause firms to fire workers because wages typically don’t fall as fast as prices for goods and services.
To provide the economy with support, the Fed is buying $85 billion of Treasury and mortgage-backed securities per month --a strategy known as quantitative easing. The central bank has pledged to keep interest rates near zero as long as unemployment is above 6.5 percent and inflation isn’t forecast to exceed 2.5 percent. Joblessness in March was 7.6 percent.
At their last meeting in March, Fed policy makers discussed scaling back the amount of monthly asset purchases and possibly ending the program by the close of the year, according to the minutes of that gathering.
The Fed probably will “postpone” consideration of such steps at its two-day meeting starting tomorrow, given recent signs of a slowdown in the economy and the still-low inflation rate, said Neal Soss, chief economist at Credit Suisse Group AG in New York and a former Fed official.
Payroll growth, retail sales and factory output all declined last month as federal tax increases and spending cuts began to take a bite out of the economy.
While policy makers don’t seem ready to sound the alarm about deflation, the “fresh disinflationary impulses” rippling through the economy give them the “green light” to keep easing, JPMorgan’s Hensley said. He sees the Fed continuing to buy debt at a clip of $85 billion per month through end-year.
The same impulses are being felt elsewhere. The Bank of Canada this month predicted inflation will stay below its 2 percent target until the second quarter of 2015, longer than the previous estimate for the third quarter of next year.
New Zealand Reserve Bank Governor Graeme Wheeler said on April 24 that weak price pressures probably will allow him to keep borrowing costs at record lows for the rest of this year. Slowing core consumer price growth is raising bets the Reserve Bank of Australia Governor Glenn Stevens will pare rates to a record next month.
Ebbing price pressures are more welcome in emerging markets, where central banks have been struggling to contain higher-than-desired inflation.
In India, annual gains in the wholesale-price index slowed to 5.96 percent in March, the least since November 2009. That’s boosted odds of easier monetary policy to help revive Asia’s third-largest economy, Raghuram Rajan, the top adviser in India’s Finance Ministry, said in an April 16 interview.
Turkey’s central bank cut its key rate by a more-than- expected 50 basis points on April 16, to 5 percent, saying weak global demand and commodity prices should “contain the upward pressures on inflation.” Hungary’s central bank last week lowered its rate to a record with inflation near a 39-year low and Mexico’s held borrowing costs at a record low as policy makers said they expect inflation to slow.
The central banks’ stance vindicates those who insisted inflation isn’t the pre-eminent threat to the world economy, said David Blanchflower, a former Bank of England policy maker.
“All those loonies saying the big fear is inflation are out of their minds,” said Blanchflower, who now teaches at Dartmouth College in New Hampshire. “The downside risks to inflation are marked.”
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