What central bank measures to use in Europe?

Equity markets started the last week of the month in a mixed mood, but recovered as the day went on. The FTSE 100 closed the day within 1% of its all time high. Overnight, Asian equities were negatively affected by a report that Chinese banks are restricting property lending. Concerns of a property bubble developing in China have been expressed in the past. Personally, I would see signs that the banks are trying to manage the situation as positive in the longer term. The Shanghai composite index fell nearly 2%, and the Shanghai property index fell nearly 5%. Commodity prices also fell.

Eurozone reported that January’s consumer price index was revised slightly higher, to a gain of 0.8% year-on-year; this is still lower than December's number of 0.9%. Mario Draghi is once again quoted that in his view there are no signs of deflation in the eurozone, but will act if he feels deflation is a threat. Interesting article in the FT today from Wolfgang Munchau, titled Europe cannot ignore its deflation problem, suggesting deflation is more of an issue than the ECB would have us believe.

In the article he points out eurozone deflation is worst for the German economy than inflation; something I have said before. Mr Munchau points out how the ECB options for QE are limited, mainly due to it being part of a monetary union, with no direct government counterpart. The conclusion to the article is that unconventional measures are needed to fend off the inflation threat, such as buying corporate bonds, bank debt and corporate equities. I personally cannot see in the near future any of those policies being adopted, so in the short term Mario Draghi will continue to try and convince the markets he has the tools to act if he sees deflation as a threat. The only tool I can think of that may be politically acceptable, at this present time, would be negative interest rates. I am not sure the European banking sector would welcome that idea.

The US equity market continues to shrug of disappointing economic data. On Monday, Markitt reported a slowdown in the US service sector in February. They also reported a slowdown in the composite PMI. Despite the slowdown, both numbers remained above the 50, indicating that the US economy is still expanding. The weather continues to get the blame for the weaker than expected data in the US. One can see from the Citi economic surprise index how recent US economic data has fallen below expectations (chart below). On the plus side expectations will be lowered for the upcoming months. It would appear in a similar way that company analysts get a little ahead of themselves at the start of the year and have to rein in expectations — the same may be said of economists.

Source: Bloomberg, Yahoo Finance

Posted on February 25, 2014 .