Prepare for normalization. With an eye to the euro. The April meeting of the European Central Bank will not present great news, but the road is marked and must be followed to the end. The markets have understood the intentions of the ECB well, and are preparing themselves, but the overall situation of monetary policy appears too accommodating with respect to the situation. Demand that is still relatively lively – as recent data on the banking sector also show – also allows for a gradual reduction in monetary stimulus without risking too much in terms of slowing growth.
Very high and lasting inflation
Central bankers are bound to be uneasy by inflation. The index rose, driven by prices beyond the control of monetary policy – energy, unprocessed food – by 7.5% in March, with underlying inflation at 3.2%. In Euroland, contrary to what happens in the United States, core inflation tends to follow the overall one, so it is conceivable that all prices now tend to rise. There is still no broad-spectrum inflation like in the US, but the number of sectors interested in higher prices than the target – apart from a few “pauses” linked to balances – is increasing. There is a real risk that inflation expectations will also rise, that interest rates and wage claims aim to recover lost purchasing power. Market measures – inflation rate swaps 5y5y – have also rapidly risen and are now pointing to 2.3%.
Rapidly rising yields
For monetary policy, which is primarily the management of expectations, it is a scenario to be avoided, to prevent high inflation from becoming a structural factor. For this reason, in March, it appeared very determined in its desire to normalize an ultra-expansive orientation, and the markets were well aware of the new indications. The yields – the GDP-weighted average – of Eurozone bonds rose relatively quickly, thus taking into account both inflation expectations and the new attitude of the ECB.
Short curve at still low levels
However, the short-term part of the curve, the one that expresses and at the same time reflects the stance of monetary policy, remains at rather low levels – lower than those prevailing at the beginning of the pandemic two years ago – and is also partially inverted. The ECB is still very focused on the end of quantitative easing and continues to argue that rates can only be increased after the end of the purchases, but one wonders if the current level of yields for maturities of less than one year is compatible with the real intentions of the central bank and with what the situation requires.
Effective exchange rate in continuous decline
One can also ask – in the awareness that the monetary policy of a single “jurisdiction” does not govern exchange rates – whether the level of the effective exchange rate, which continues its descent, is consistent with the current situation. In a phase of high inflation, a falling currency lets Euroland add inflation: in six / seven months the common currency has lost 8.4% of its value against the dollar, the international payments currency with which purchases of gas, oil and many other products. In this sense, careful monitoring of the currency level, even if not declared, is one of the tasks that the ECB will have to carry out.