Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
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Chart of the Week: PIIGS HICP YoY
Christopher Dembik
Head of Macroeconomic Research
Summary: More than the slowdown in economic activity, which is well-reflected in very weak manufacturing sentiment, current level of inflation (both headline and core inflation) released for the month of July are particularly concerning and add to the case for new ECB action next month.
This is one of the charts that probably scares the ECB the most. More than the slowdown in economic activity, which is well-reflected in very weak manufacturing sentiment, current level of inflation (both headline and core inflation) released for the month of July are particularly concerning and add to the case for new ECB action next month. In his latest press conference, Mario Draghi made many references to “we don’t like it” when talking about the level of inflation.
Weakness of inflation is broad-based, even in Germany where HICP surprised to the downside, at 1.1% YoY in July. What is even more worrying is that PIIGS countries are lurching towards deflation again: Italy’s HICP was out at 0.4% YoY last month, and Spain’s HICP dropped to minus 0.7% YoY, the lowest level since July 2014!
The ECB is going to have to find some way of responding, probably by lowering the deposit rate by 10 basis point and relaunching QE at some point in coming months. However, as lowflation is foremost related to structural factors (we have pointed it out many times: notably ageing, new technology and debt), it is unlikely that a new round of easing will have a positive long-term impact on HICP. The ECB needs to rethink its mandate, which primarily focuses on maintaining price stability, and broaden it to new missions, such as fighting unemployment or financing the green transition. Nothing new, since it has been widely debated among economists and market participants over the past years but, at some point, the ECB will really need to tackle this issue. It is a matter of credibility.
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