The travails Europe’s periphery



  • China raises reserve requirements once more
  • Plosser says ‘not inconceivable’ Fed could hike this year
  • More inflation worries for the ECB
  • Sentance remains an unrepentant hawk

Guest post by FXPro

The recent renewed focus on the troubles in the PIGS intensified on Friday, resulting in a further widening in bond spreads and some softness in the euro. Indeed, last week was notable for the constant stream of bad news emanating from Europe’s highly indebted economies. In particular, the suggestion from German FinMin Schaeuble that Greece just might need to restructure its debt (a fairly obvious thing to say, actually) seemed to be a particular trigger for renewed angst. Greek CDS widened once more on the last day of the trading week, to 1175bp over five years, while the 10yr yield jumped 55bp to 13.82%. Moody’s added to the negativity by downgrading Ireland’s credit rating to the lowest investment grade of Baa3. At one stage on Friday, the Irish 10yr yield rose 20bp to 9.52%. Spain was not immune – the 10yr blew out another 11bp vs Bunds on Friday. The single currency drifted lower over the course of Friday and again overnight – in early London trading, it is below 1.44.


Commentary

China raises reserve requirements once more. Yet another 50bp increase in bank reserve requirements was announced by the PBOC over the weekend, lifting the ratio to a record 20.5%. After the decision was announced, PBOC Chief Zhou Xiaochuan claimed that the process of tightening monetary policy could continue for some time. Key interest rates have already been raised on five separate occasions, and after last week’s strong GDP and inflation data, another increase could follow soon. Chinese officials also appear to be more receptive to allowing the yuan to appreciate slightly more rapidly as a way of helping to combat imported inflation. Since June of last year, the yuan has appreciated by 4.5%.

Plosser says ‘not inconceivable’ Fed could hike this year. Now that would be a thing. Philly Fed President Plosser reiterated on Friday that the Fed could afford to raise rates before the end of the year, and that it could sell assets at about the same pace as they purchased them. Plosser is becoming agitated by signs that inflation is picking up – in March, the CPI rose by 2.7%, up from 2.1% in the previous month. However, other Fed officials such as William Dudley, Elizabeth Duke and Narayana Kocherlakota seem much less worried about inflation, the latter recently declaring that core inflation ‘is very low right now’. For the year ended March, the core inflation rate was just 1.2%. Given the still parlous state of the labour market, a rate hike over the next couple of quarters looks highly unlikely.

More inflation worries for the ECB. Europe’s central bankers will no doubt ponder closely the latest inflation data, which shows that the HICP rose to a 29m high of 2.7%, above expectations. Ex energy, HICP rose by 1.5% YoY in March. ECB Vice-President Constancio was on the newswires early on Friday, reiterating that inflation remained a concern. And over the weekend, Austrian Central Bank Chief Nowotny suggested that market expectations for another 50bp of tightening from the ECB this year were ‘well-founded’, while Belgium’s Luc Coene stated that monetary conditions were too accommodative. Departing Bundesbank President Axel Weber suggested that there was ‘a significant increase in inflationary pressure’.


Sentance remains an unrepentant hawk.
There are no signs that UK MPC member Andrew Sentance is relenting from his hawkish read on British monetary policy, despite the fact that his tenure is almost at an end. He claims that the weakness of the currency may well push inflation up through 5%, and that imported inflation would be less if the pound were a little stronger. Sentance contends that a rate hike might help the pound to strengthen somewhat, reducing the incredible squeeze on living standards. He feels that the pound is weaker than it should be to rebalance the economy, thereby contributing to inflation and making macroeconomic management more difficult.




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