Blondemoney had only thought that Draghi was engaged in his dance of deflationary doom, but it now seems that after he’s waltzed his way around the dancefloor, spinning his ECB partners into a QE frenzy, he’s dragged a few other wallflowers onto the dancefloor. Over 25 central banks cutting in the past 3 months demonstrates just how much this party is now jumping. The sheer scale and pace of the plunge in the Euro has got everyone hot-stepping. As the Riksbank pointed out last week, with their surprise intra-regular-meeting rate cut, ‘There are signs that inflation has bottomed out and is beginning to rise, but the recent appreciation of the krona risks breaking this trend‘. The thing is, the krona hasn’t appreciated that much on a trade weighted basis, what with it losing ground against the dollar as it has rallied against the Euro – see below for the Riksbank’s own TWI (called the KIX) against EUR/SEK:
So it’s the Euro specifically that is causing so much heartache for the world’s central banks. Sterling is not immune, and its rally against the Euro to eight-year highs seems to have put the deflationary cat amongst the pigeons round at the Bank of England. Andy Haldane’s speech last week ruffled feathers after his comment: ‘I think the chances of a rate rise or cut are broadly evenly balanced. In other words, my view would be that policy may need to move off either foot in the immediate period ahead, depending on which way risks break.‘
Hang on a minute, oil prices may have tumbled so much that inflation now risks a negative print, but didn’t we look through the transitory nature of inflation at 5%? Not least because people may have more money in the pockets after filling the car up (yes please I will have a Kit Kat with that).
Here’s the key charts from Haldane’s speech, however. It’s the lack of wage inflation that is causing so much angst. Here’s how the Phillips curve is flattening in both the UK and the US:
In fact, the slope of the Phillips curve is declining globally:
Now there may be many reasons for this, not least changes to the way people work thanks to technology and globalisation. The question is, should central banks take it into account, and if so, how?
Haldane explains that it can become a self-reinforcing problem if inflation expectations also plummet – and currently inflation expectations haven’t been lower since the financial crisis.
If you need to shock inflation expectations higher, you may need to look no further than the Draghi QE and negative rate playbook. The question is, do you want to join the deflationary dancefloor frenzy? Or will a stronger currency force you into it?