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Why is lower inflation unlikely to deter the ECB from further rate hikes?

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Inflation in the eurozone fell back to single digits in December, with data published Friday morning showing the core rate hitting 9.2 per cent after annualized price growth topped 10 per cent in the previous two months.

Until now Slower It is unlikely to be enough to convince the ECB to stop raising interest rates just yet, with markets continuing to price in a series of hikes by officials in Frankfurt over the course of 2023.

“The ECB is likely to stick to its hawkish rhetoric in the near term despite the large declines – and the potential for further sharp declines this year,” said Francesca Palmas, chief economist for Europe at research group Capital Economics.

Why isn’t a fall enough to convince the ECB to change course?

While lower fuel prices and government subsidies to help businesses and households out of soaring electricity bills cut headlines inflation rates, underlying price pressures remain strong.

Berlin paid most household gas bills for December, which economists at Commerzbank estimated was 1.2 percentage points lower than the harmonized rate of headline inflation. the average He fell to 9.6 percent, down from 11.3 percent in the previous month. But growth in the cost of services, an indicator of how far price pressures are likely to persist, accelerated in December.

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The line graph of annualized percentage change shows that German headline inflation has declined, but underlying pressures remain

In Spain, the core CPI inflation rate – which excludes food and energy price movements – rose in the year to December, although it fell sharper than expected in the headline coordinated rate to 5.6 per cent.

Although core inflation in the eurozone fell from a record 10.6 per cent in October to 10.1 per cent in November, core inflation – at 5 per cent – remained at an all-time high. He is expected to remain there in December.

“This year will mostly be about falling under the blanket of inflation and seeing exactly what drives it,” said Paul Hollingsworth, chief European economist at French bank BNP Paribas.

For the ECB to change course, rate-setters will want to see a significant decline in the base rate and other measures of long-term inflationary pressures, such as wage growth. They will also look for signs that government support for households and businesses struggling with higher energy prices is boosting demand.

Christine Lagarde said interview With the Croatian newspaper Jutarnji List: “We need to be careful of the internal causes [of inflation] What we are seeing, mainly related to fiscal measures and wage dynamics, is not consolidating inflation.”

What’s next for inflation in Europe?

More declines are expected in the coming months, after decreases energy prices since the beginning of the year. And the impact of the increase in energy costs last year in the aftermath of Russia’s invasion of Ukraine will soon slip through the index, lowering the headline number significantly.

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Carsten Brzeski, head of macro research at Dutch bank ING, predicted that inflation in the eurozone could fall back to the ECB’s 2 percent target by the end of 2023.

If the recent declines in gas prices continue, the ECB will almost certainly have to lower its inflation forecasts for this year. The central bank said in December that prices would rise 6.3 percent over the course of 2023, based on the assumption that natural gas prices average €124 per megawatt-hour over the entire year.

But the price of the TTF benchmark European gas contract is down about 10 percent this week to 69.70 euros/MWh as of Thursday afternoon – a level 80 percent below the August high of 340 euros/MWh.

“The ECB’s inflation expectations are currently very high, just judging by the technical assumptions of gas and oil prices and where those prices are currently,” Brzeski said.

What does this view of interest rates mean?

Last year, the European Central Bank responded to soaring inflation by raising interest rates at an unprecedented pace, raising the deposit rate from 0.5 percent in July to 2 percent by the end of the year.

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European Central Bank President Christine Lagarde said in December that markets were underestimating the magnitude of higher borrowing costs, adding: “We should expect a 50 basis point hike in interest rates for a while.”

Since then, investors have been seeking about 1.5 percentage points of price increases over the first three quarters of 2023.

The interest rate rose by half a point at officials’ next policy meetings in February and March, and some smaller moves later in the year remain the outlook, despite sharper-than-expected declines in inflation this week.

Line graph of expectations of the level of the deposit rate by September 2023 (%) shows that markets still believe that the ECB will raise interest rates aggressively

Without sharper declines in measures of underlying price pressures, it is unlikely that markets and economists’ expectations for interest rates in the eurozone will change significantly.

“Everything goes back well to an inflation rate of 3 or 4 percent,” Hollingsworth said. “But it may be difficult to get down to 2 percent, especially if there is a more moderate recession than expected.”

“We really need to see service prices and wage growth soften to convince the ECB that it has done enough,” he added.

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Additional reporting by Valentina Romei


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Central banks can’t win when it comes to inflationary credibility

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The writer is a former central banker and professor of finance at the University of Chicago Booth School of Business

Why does the US Federal Reserve find it so difficult to convince the market that it means business when it comes to not cutting rates? The minutes of the December meeting clearly stated, “No participant anticipated that it would be appropriate to begin lowering the federal funds rate target in 2023.” However, this hawkish statement did little to change market expectations, making the Fed’s task of slowing the economy even more difficult.

Central bank statements have an impact because people still believe that institutions will do what they say. This credibility is obtained through a combination of central banks’ reputations (either dovish or hawkish), past actions, and the policy tools they possess and the frameworks under which they operate. Unfortunately, the kind of credibility needed to escape a system of very low inflation, which we had until recently, is different from the kind needed to curb high inflation, which we have now. Credibility, by its very nature, does not turn into a dime.

Traditionally, central banks have grappled with high rates of inflation. Government spending usually overestimates the economy to generate growth. Central banks helped and abetted this, not only by keeping interest rates low, but by financing government spending. In the process, they managed to stoke inflation, which hurt growth where it had taken hold. Then, perhaps learning from the Fed under Paul Volcker, countries decided it was best to have an independent technocratic central bank, mandated to keep inflation in check through an inflation targeting framework. Thus, banks gained credibility as an inflation fighter.

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But after the global financial crisis, inflation dropped dramatically, making the challenge push it up again. In order to increase inflation, central banks had to develop a new kind of credibility. In the words of economist Paul Krugman, they should have “credibly promised to be irresponsible” when they saw inflation, by committing to curbing it rather than fighting it furiously.

And so central banks adopted a new set of tools. Quantitative easing, for example, whereby the bank announces that it will buy government bonds for an extended period, worked in part by requiring the bank not to raise interest rates until the announced buying program ends. In fact, this may be part of the reason why both the Federal Reserve and the European Central Bank were slow to raise interest rates when inflation picked up in late 2021. Central banks also acted in ways that undermined beliefs about their intent to raise rates, as they did when they halted rate increases. After the markets started to faint in late 2018.

Finally, central banks have changed their frameworks to include inflation tolerance within them. A key component of the Fed’s new framework, adopted in 2020, was that it would not be preemptive in avoiding inflation. The old mantra abandoned, if you’re staring at swelled eyeballs it’s already too late.

While none of this was particularly effective in raising inflation, it may have encouraged the government to spend more, knowing that the central bank would not raise interest rates quickly. When the pandemic hit, there were few restrictions on government spending that, along with the war in Ukraine, pushed us back into a system of high inflation. But central banks again find themselves with the wrong kind of credibility – that is, the assumption that they will tolerate inflation. No wonder markets continue to price in Fed cuts, even as the Fed insists it won’t become accommodative until inflation is tamed. In short, the credibility of a central bank is useful only when it is relevant to the inflationary system it faces.

Should the Fed act again to restore its credibility as an inflation hawk? It takes a long time to build credibility, and inflation regimes can change again. It is not inconceivable that an aging population, declining immigration, deglobalisation, and a slowing China could push the world back into a low-growth-inflationary environment.

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However, central banks are likely to be more effective if they rebuild their commitment to combating high inflation. And if inflation gets too low, maybe we should learn to live with it. It’s hard to argue that all the frantic activity in the recent low-inflationary regime was effective, distorting credit, asset prices, and liquidity in ways that hurt us today. But as long as low inflation does not collapse into a rapid deflationary spiral, central banks should not worry excessively. Instead, they should shift the burden back to governments and the private sector when it comes to achieving sustainable growth.

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Biden declares state of emergency in California due to winter storms via Reuters

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© Reuters. FILE PHOTO: US President Joe Biden delivers remarks during a ceremony marking two years since the January 6, 2021 attack on the US Capitol in the East Room of the White House in Washington on January 6, 2023. REUTERS/Kevin LaMarque

(Reuters) – US President Joe Biden approved a declaration of emergency for California after a week of storms that killed at least 12 people in the past 10 days and knocked out power to hundreds of thousands of homes and businesses in the state.

The White House said in a statement that the emergency declaration authorizes the Federal Emergency Management Agency (FEMA) to coordinate disaster relief efforts and mobilize emergency resources.

Last week, severe weather brought violent gusts of wind that toppled trucks, flooded the streets of small towns along the Northern California coast, and led to a storm that destroyed a dock in Santa Cruz.

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Foreign policy experts say Russia is in danger of becoming a failed state

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Nearly half of leading foreign policy experts believe Russia will become a failed state or disintegrate by 2033, while large majorities expect China to try to take Taiwan by force, according to a new survey by the Atlantic Council that points to a decade of global globalization. Coming troubles.

Forty-six percent of the 167 experts who responded to the think tank said Russia’s failure or disintegration could happen in the next 10 years. In a separate question, 40 percent indicated Russia as a country they expect to disintegrate due to reasons including “revolution, civil war, or political disintegration” during that time.

said Peter Engelke, deputy director for forecasting at the Atlantic Council, who helped design and interpret the survey.

Western officials say Russia has been greatly weakened by its action Ukraine invasion 11 months ago, including via sanctions and export controls. Economists believe that Russia’s productive capacity is steadily deteriorating as a result of punitive measures, setting the country back by decades.

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Russian President Vladimir Putin has begun publicly acknowledging that Moscow faces setbacks in Ukraine and that the conflict will take a long time. The United States and its Western allies have pledged to support Ukraine for as long as they can, with all sides making plans to drag the war on for years.

Even as Europe is experiencing its biggest territorial conflict since World War II, the majority of experts surveyed said they did not think Russia and NATO would directly engage in military conflict in the next decade.

However, 70 percent of respondents predicted that Beijing would do so in the next ten years, backing up increasingly dire warnings by US officials that China would launch a military offensive to retake Taiwan.

US military leaders have pointed to 2027, the centenary of the founding of the Chinese People’s Liberation Army, as a possible invasion date. However, some officials have stepped up their warnings about Beijing’s intentions over the past year, and have said an invasion was possible before 2024.

US President Joe Biden has said repeatedly that Washington will defend Taiwan from Chinese attack, even as the US has historically tried to avoid articulating what it will do to deter both sides from acting.

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Other findings add to the picture of global chaos. Nearly 90 percent of respondents believe that at least one additional country will have nuclear weapons by 2033. Sixty-eight percent of them said Iran would be most likely to obtain a nuclear weapon, coming as possibilities for reviving a nuclear deal between the six world powers and becoming Iran is increasingly bleak. Echoing some optimism, 58 percent of experts said they believed nuclear weapons would remain unused over the next 10 years.

Foreign policy experts also predicted a certain degree of American backtracking. While 71 percent of those surveyed expect the United States to continue to be the world’s dominant military power by 2033, only 31 percent believe the United States will be the number one diplomatic power and 33 percent the preeminent economic power.

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