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For the ECB, the world has changed a lot in 49 days

While the ECB had announced new monetary easing measures on 3 December, it said on Thursday 21 January that it will need to reconsider its monetary policy at the March Governing Council (a message on which all governors, including Jens Weidmann, are unanimous). How can the global perception of one of the world's largest central banks have changed that much in 49 days?
First, oil prices have collapsed over the past few weeks. In a situation of already overabundant supply, with inventories at record levels, Iran's comeback on the international markets has weighed heavily on prices (oil prices lost around 35% since early December). This drop in energy prices is mechanically weighing down inflation, but it is also dragging down inflation expectations in the Eurozone as well as the United States. Professional forecasters expect inflation to rebound even more slowly than expected and to reach only 1.6% in 2018 in the Eurozone. The fact that the euro and the dollar have climbed steeply in effective terms over the last weeks (respectively +5% and +3.7% between early December and the ECB governing council) increases deflationary pressures. Notably, Mario Draghi appeared very pessimistic about the evolution of core inflation and wage inflation.
Then, the fresh episode of renminbi's depreciation (down 1.3% against the US dollar since the start of the year) has rekindled fears over the Chinese economy in particular and over emerging economies in general. The recent worsening growth outlook in the emerging countries is darkening the outlook for the Eurozone. Furthermore, the IMF dramatically lowered its GDP growth forecast for Brazil (the 2016 forecast has been cut to -3.5% from -1%).

Questions about a possible more pronounced slowdown of the global economy sent the equity markets and the credit markets spiralling since the beginning of this year. The rise in risk aversion pushed up the traditional safe havens: the yen is back to its highest level for more than one year and the US 10-year yield is close to 2%. Incidentally, profit growth for US companies during the cycle was essentially the result of expanding margins, which hit record levels thanks to strong cost contraction and very weak wage growth. Thus profit growth is now extremely sensitive to sales trends and the outlook is hobbled by the US dollar's appreciation and the drop in oil prices. Investors are all the more worried by the outlook of profits growth as the balance sheet of US companies worsened (financing of mergers and acquisitions and share buybacks). In Europe, the leverage ratio is lower but profit growth may be dampened by any appreciation of the euro. For the ECB, the volatility of the markets constitutes an unwar-ranted tightening of financial conditions.

So for an economy like the Eurozone's, which is still fragile, all it took was 49 days for the picture to get a bit bleaker. On 10 March, the ECB will be duty-bound not to disappoint, and, as we have seen, a cut to deposit rates and a time extension on its QE will not be enough.

  

2016-01-22-focus
Bastien Drut & Valentine Ainouz, Strategy and Economic Research at Amundi
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For the ECB, the world has changed a lot in 49 days
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