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Eurozone economic data indicates ECB may go for QE tapering only from Dec’22 and never hike rates

calendar 07/09/2021 - 19:40 UTC

On Tuesday, Eurostat data shows that the Euro Area (EA) or the Eurozone (EZ) Q2CY21 GDP growth was revised higher to +2.2% (flash estimate +2.0%), as the EA emerged out of technical recession following GDP contraction of -0.3% in Q1CY21 and -0.4% Q4CY20. In the last two quarters, there were lingering Delta (COVID) disruptions, whereas, in Q2CY21, economic activity rebounded amid rapid progress of COVID vaccinations and subsequent reopening of the economy/country. The Eurozone economy was expanded by +14.3% yearly in Q2CY21, the highest on record, reflecting a low base amid COVID lockdown 1.0. On a nominal basis, in Q2CY21, the real GDP was around €27.7714B against €24.2922B in Q2CY20 and Q2CY19 (pre-COVID) levels €28.4189B.

Eurozone Real GDP (QLY)

Overall at a glance, assuming no further big COVID wave/lockdowns, the Eurozone real GDP may grow around +0.50% sequential trend rate and reach around €11.08T by 2021 against €10.64T in 2020; i.e. the real GDP growth between 2021-20 maybe around +4.06%. But the 2021 real GDP would be still lower by around €0.31T from pre-COVID 2019 levels of €11.38T; i.e. -2.69%. In that scenario, with a normal growth rate of around +0.50% sequential (q/q); i.e. +2% annualized rate, the Eurozone real GDP may reach the pre-COVID levels of around €11.38T by Dec’22 or Mar’23.

On the inflation front, the annual core HICP inflation jumped +1.6% in Aug’21, most since July’12, but primarily due to low base effect (y/y). On a sequential basis (m/m), the core HICP CPI declined -0.44% in Aug’21. In 2021, core HICP CPI is increasing by around +0.23% on an average sequentially; i.e. +2.76% on an annualized basis (till Aug’21). The core HICP inflation index was 104.36 in Jan’21 (from 104.93 sequentially in Dec’20), reached a high 106.53 in June’21 so-far and again fell to 106.06 in Aug’21 in a typical zig-zag pattern.

 

Euro Area core HICP inflation index

U.S. core PCE inflation index

In 2019, the Eurozone core HICP inflation was around +2.83% on a 12-month basis (Jan-Dec); i.e. +0.24% on an average sequential rate. The core HICP inflation index was 101.80 in Jan’19, reached a high 104.83 in Oct’19, and closed the year at 104.69 (Dec’19) in a typical zig-zag pattern.

In 2020, the 12-month Eurozone core HICP inflation was around +1.96%; i.e. +0.16% on an average sequential rate. The core HICP inflation index was 102.91 in Jan’20 (from 104.69 sequentially on December 19), reached a high of 105.59 in June’20 and closed the year at 104.93 (Dec’20), again in a typical zig-zag pattern.

Although ECB always talks about HICP inflation, in reality, for policy setting, it refers to core HICP inflation, not the headline. And unlike the Fed’s measure of 12-months core PCE inflation, ECB always refers to the yearly rate of inflation of a particular month. Unlike the U.S., core inflation and also headline CPI index is abnormally volatile in the Euro Area leading to lower Y/Y reading persistently, although, if we measure on an annualized (12-month) basis, the Eurozone core HICP inflation was around +2.83% in 2019 and +1.96% in 2020. And in 2021, the annualized core HICP inflation rate is around +2.76% (till August).

The Eurozone core HICP inflation was around +1.3% in Dec’19, +0.2% in Dec’20, and +1.6% in Aug’21 on a y/y (yearly) basis, always far below the +2.0% target. Thus officially, in the last decade, the Eurozone core HICP inflation never hit the target of ‘just below’ +2%, helping ECB to keep Euro Area interest and bond yield rate always at lower bund or near zero. Such sequential (m/m) volatility on core/headline HICP/CPI index is quite abnormal; be it statistical jugglery or fragmentation of Euro Area countries, it leads to the deflation-like scenario for the Euro area economy.

The number of Eurozone employed persons was around 160.98M in Jan’20 (pre-COVID) against 157.62M in Mar’21; i.e. still around -3.42M down. In the June policy meeting, ECB President Lagarde mentioned these 3M people, who need to be employed for any substantial progress for QE tapering. And if we consider extended PUA for Eurozone, this number may be much higher.

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In Euro Area 19 member states (countries), all are not strong economies like Germany, Belgium, Netherlands, or Austria. Even France, Italy and Spain have a quite fragile economy, running structurally high debt compared to the EU Gold standard. Moreover, peripheral economies like Greece, Portugal are quite fragile. Thus, ECB has to ensure lower borrowing costs for these fragile economies in years to come by keeping inflation, interest rates and bond yields lower.

The ECB is also open to extending the PEPP beyond Mar’22 until the Governing Council (GC) judges that the coronavirus crisis phase is over and there is substantial progress of ECB’s single mandate of price stability (inflation on a durable basis). At the current trend of core inflation rate (y/y), the ECB will never be ‘able’ to achieve the ever-elusive target of 2% (y/y) and thus will be at present lower bound until at least 2025 or forever!

ECB is not been ‘satisfied’ with consistent inflation ‘misses’ over a decade and its policy credibility is also now at stake. The ECB was never able to stimulate the economy even by its perpetual ultra-accommodative monetary policy due to lack of adequate fiscal stimulus. Thus ECB miserably ‘failed’ to achieve its inflation target and was never able to hike (normalize) after the 2008 GFC due to the fiscal austerity policy of many EU member states and lack of common fiscal authority.

Now ECB is urging EU member states to take necessary steps for implementation of the common EU Next Generation fiscal/infra stimulus (NGU) immediately, while various EU member states are still divided on the same. This lack of common fiscal authority despite a common currency (EUR) and common monetary authority (ECB) may be the main reason behind EU inequality and fragmentation.

The ECB’s current policy of back-door YCC through targeted PEPP (bond-buying) may also accelerate the ‘Japanification’ of the Eurozone economy, making EUR like Japanese Yen- more like funding rather than growth currency. Like Fed, the ECB is also ensuring EU borrowing costs at ultra-low levels to fund NGU; and for that ECB may not taper PEPP even in Mar’22 and replace it with another QE.

After the 2008 GFC, ECB was several years behind Fed in QE tapering and this time, it may be the same. The ECB has practically no weapon left except targeted PEPP (backdoor YCC) and ‘powerful’ forward guidance (jawboning) in keeping EU bund yields lower, especially on the peripheral areas; ECB was at almost ZIRP since 2008 GFC and can’t cut lending (repo) rates below zero. The policy divergence between ECB and Fed/BOE is making EUR lower, but as an export-heavy economy, the EU also needs weaker currency, irrespective of ECB and inflation narrative. Looking ahead, ECB may be more comfortable to keep EURUSD around between 1.20-1.10 rather than 1.20-1.30.

Bottom line:

Thus officially, as Eurozone inflation is running consistently far below the +2.0% target, ECB never tried to hike rates after the 2008-10 GFC and 2013 debt crisis. Going forward, ECB may also be never able to hike rates (normalization) but may go for QE tapering from Dec’22 or Mar’23 after Fed completes its QE tapering by Sep’22 and goes for liftoff from Dec’22 (as expected).

Technical outlook: EURUSD (LTP: 1.18400)

Technically, whatever may be the narrative, EURUSD now has to sustain over 1.9200-1.19800/1.20000 for a fresh rally towards 1.20600-1.22700/1.23000; otherwise may correct again towards 1.17000/1.16600-1.16000-1.13900.

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