Draghi Pans Rate Hike Despite Inflation
Higher inflation figures announced for the Eurozone have increased calls for European Central Bank (ECB) President Mario Draghi to end the ECB’s bond-buying initiative, and join the U.S. Federal Reserve in raising interest rates. Draghi was upbeat about the euro in a speech given on Monday. However, he is still cautious about ending the qualitative-easing (QE) program which has keep rates artificially low to counter the effects of the global recession which began in 2008.
Draghi Is Not Tempted to Raise Rates by Economic Recovery
Several economic indicators are pointing to a sustained recovery, including low unemployment, an increase in lending. The inflation rate has now met the ECB’s target for the first time since 2013. The average household income is also rising, leading to increased consumer consumption. Draghi still advocated for moderation in terms of economic policy because forecasts still call for the inflation rate to drop back below the target in the near future.
Winter May Be Behind Inflation Hike
Improved inflation numbers in February were likely due to an increase in prices for utilities. Rates hit 2 percent for the first time since January 2013. However, much of this is related to winter weather. When analysts looked to the core inflation figures, which do not take into account utility or food costs, rates were stagnant. This makes a good case for Draghi’s argument that QE is still required to stimulate the European economy.
Eastern Europe Worries about Early Rate Hikes
Eastern Europe, in particular, worries about the impact of a rate increase implemented too early. Many of the leading economists from Poland, Hungary, and Czech Republic supported similar measures by the ECB in 2012. But an sudden economic downturn required Jean-Claude Trichet, then ECB Governor, to reverse the rate decision after only six months.
At the time, Adam Glapinski, currently in charge of Poland’s central bank, was one of the Monetary Policy Council members who backed the rate increase. Now, he is noting that policy rates should remain on hold until forecasts predict a lasting change in inflation. Glapinski says he sees no “grounds for rate hikes this year. What’s more, based on this projection, I wouldn’t see any need for tightening even in 2018.”
Several Countries Are Pressuring the ECB to End QE
Germany is leading the call for increasing rates, as the country’s inflation has already reached a robust 2.2 percent. The heads of the central banks of The Netherlands, France and Spain have also joined in on calling for QE measures to stop. The issue has become increasingly partisan as right-wing political parties from each of these countries are accusing the EU of supporting poor performers like Greece and Italy at the expense of dragging down economic growth. The world is currently watching the election taking place in The Netherlands to see if Geert Wilders, the leader of the conservative Party for Freedom, can parlay his criticisms of the ECB and the EU into a win at the ballot box.
Investors Expect the ECB to Raise Rates within 18 Months
During his speech, the ECB President dropped reference to the ECB combatting deflation by using “all the instruments available in its mandate”. Investors did not overlook Draghi’s subtle change in tone. After hearing this, market sentiment that rates would increase by the end of August 2018 nearly doubled. Last week, only a third of analysts expected a rate hike. This week, investors are pricing the chance of an increase at 68 percent.
Tech Could Spur the European Economy
Draghi pointed to technological advances as the key to economic improvement in his conference speech. Innovation, and most importantly, its spread, can promote productivity. According to Draghi, higher productivity is the only way that Europe can maintain the wages and social programs that provide economic security. In that light, Draghi suggested increase spending on research and technology.
How Does the Inflation Rate Affect Trading?
The euro has already begun rising on the strength of Draghi’s assessment that the European economy is improving. Europe’s relative stability should also drive investors away from gold to the euro. If Europe continues to add jobs, this may lead the pound to drop as investors worry about the wisdom of the U.K. separating from a strong region. The cap on interest rates will hurt the European banking industry, as it tries to recover from its series of non-performing bank loans. Look for the banks to drag down the London FTSE.