Friday September 15, 2006 - 15:45:16 GMT
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FX Briefing 15 September 2006 - Inflation is slowing down significantly in eurolandHighlights
â€˘ New government leader could increase political pressure on BoJ
â€˘ FOMC extends rate pause, tightening bias remains
â€˘ Inflation outlook in the eurozone is brightening up â€“ not just temporarily
Inflation is slowing down significantly in euroland
There is a long string of political events on the agenda next week starting this Saturday when the G7 finance ministers and central bank governors meet in Singapore, and going on until Tuesday and Wednesday, the official part of the IMF and World Bank annual meeting. US Treasury Secretary Henry Paulson will visit Chin from Tuesday to Friday.
IMF, LDP and FOMC
In the last few days, so much has been written and spoken on the subject of â€śglobal imbalancesâ€ť, that there is little to add. It is becoming increasingly clear that politicians are very reluctant to make statements on exchange rate policy. China (and other emerging market nations in the region) are still being urged to make their exchange rates more flexible, but the Chinese governmentâ€™s cautious approach is likely to be respected. Otherwise, the solution to the problem of global imbalances is seen to be in stronger domestic demand in the surplus regions (emerging Asia, commodity producers, Japan), and also Europe.
On Wednesday, the LDP is electing its new president. Shinzo Abe is widely viewed as the frontrunner and would thus also be the designated successor of prime minister Junichiro Koizumi. At present chief cabinet secretary, he is perceived as belonging to the conservative wing of the LDP. Given his views on monetary policy, there could be more political headwind to future BoJ rate rises.
There is also an FOMC meeting mid-week. The latest data more or less confirm the FOMCâ€™s expectations that Q3 growth will be just below potential. The risks for the housing sector might indeed be seen to be more severe, but there is not likely to have been an increase in macroeconomic risks: investment activities outside residential construction seem to be strong, the increase in employment and wages plus the current decline in energy prices are supporting private consumption. High capacity utilization, the acceleration in wage cost increases and the present high inflation rates all indicate that the inflationary risks persist. Furthermore, recent comments made by Fed representatives suggest that the Fed will extend the rate hike pause with a tightening bias for a further five weeks. Its statement for the press will probably be very similar to the one issued on 8 August.
Disinflation in Euroland
While ECB representatives are still professing their determination to continue tightening monetary policy, a surprise is brewing on the data front. For if our forecast proves to be correct, the German inflation rate could plunge in September from its current level of 1.7% to 1.0% or even slightly less (!). The reason for the sharp decline is that last yearâ€™s base is very high due to the energy price peaks in September and October 2005. This effect was foreseeable. However, energy prices have been developing very favourably over the last few weeks on top of this. WTI is currently around $63/b, almost 20% below the peak in July.
Fuel prices, which had already been declining slightly in August, could have dropped further by about 7-8% in September. On the whole, the reduction due to the present energy price drop could be almost 0.3 percentage points. Furthermore, other non-energy prices have also been developing fairly moderately recently â€“ weaker than in the same period last year. The result of all these factors is the aforementioned decline in the inflation rate in Germany.
Of course these influences can also be seen at the European level too. We thus consider it feasible that the EMU inflation rate will fall from 2.3 to 1.9% in September, below the ECB upper limit of 2%.
The spectacular declines are partly of a temporary nature. In November and December, the base effects will become less significant, and inflation will climb up again. The German VAT increase comes into effect in January and its price-driving impact will probably be evident in EMU consumer prices too.
Nevertheless, the inflation situation has improved considerably. The decline in energy prices (and other commodity prices) is dampening price pressure. If the oil price remains roughly where it is today, the ECB could for the first time revise its inflation forecast for 2007 downwards. At present, the forecast is around 2.4%; our estimate is currently just over 2% â€“ despite the VAT increase. In this case, inflation rates could rise to 2.5% again in the first quarter of 2007, but as from Q2, they could fall below the ECBâ€™s target again. The first forecast for 2008, to be issued by the ECB in December, could actually be below 2%.
Even if the favourable economic situation and monetary development still speak for further ECB tightening, the change in the inflation outlook makes raising interest rates in the eurozone less urgent. In our view, this enforces the possibility of the yield curve, which is currently very steep at the short end, flattening in the near future, which could in turn also weaken the euro.
Stephan Rieke +49 69 718-4114
+49 69 718-3642
Foreign Exchange Trading
+49 69 718-2695
Matthias Grabbe / Klaus NĂ¤fken
+49 69 718-2688
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