Rising yields put pressure on ECB - Capital Economics
European Economics

Rising yields put pressure on ECB

European Economics Weekly
Written by Jessica Hinds

The surge in euro-zone government bond yields this week has ruffled the feathers of the doves at the ECB, who are keen to look through short-term upward forces on inflation. The still-high number of virus cases, the potential reimposition of restrictions and the comparatively leisurely pace of the vaccine rollout raise the risks of a later and slower economic rebound, making a supportive ECB all the more important. Next week we expect data to show that euro-zone core inflation fell back in February.

ECB tries to quash bond yield increases

Euro-zone sovereign bond yields continued to rise this week in line with those elsewhere, as investors reassess the global inflation outlook and related prospects for monetary policy.

While inflation has risen in the euro-zone at the start of the year, data this week confirmed that this has largely been down to one-offs. (See here.) And although some longer-lasting upward forces on inflation, notably energy and the current supply shortages in manufacturing, might boost the headline rate over the rest of the year with German inflation exceeding 3%, that is likely to be reversed in 2022. The big driver of underlying price pressures is still aggregate demand, which remains weak. It is no wonder then that ECB officials are feeling uncomfortable, with policymakers trying to quash verbally the latest rise in yields. Action is likely to follow words, if indeed it hasn’t already. (See here.)

Virus variants and vaccine woes

The ECB will be keen to ensure that financing conditions remain ultra-loose given that the risks to the economic recovery appear to be growing once again. While lockdowns have been successful in reducing the spread of the virus, new daily infections in the euro-zone have stabilised over the past week or so at just under 200 per million people. That is still high – it’s twice the rate last September, prompting governments to worry about lifting measures.

In France, where the government has been desperate to avoid a third full lockdown, virus hotspots have this week been placed under lockdowns at weekends. Other areas may well follow, including the Paris region. And in Italy, which loosened some restrictions recently, cases are rising once again too.

All this serves to strengthen our view that the euro-zone economy will contract in Q1. Beyond that, our current forecasts assume that most of the economically damaging measures will be lifted by the second half of Q2. But the slow vaccination rollout is casting a shadow, with some of the largest euro-zone economies dragging their feet on administering the vaccine doses they have received. The chances of a later and slower rebound in activity are growing.

Glum consumers sitting on their savings

Against this backdrop, it’s no surprise that consumer morale has remained depressed. The EC survey for February published this week showed that euro-zone consumers are reluctant to make major purchases, while savings expectations for the next 12 months are close to a record high. (See Chart 1.) Data published today showed that in Q4, France’s household savings rate rebounded to 22.2% of disposable income, well above 2019’s 14.9%.

Chart 1: EZ Consumers’ Savings Exps. For Coming Year

Source: Refinitiv

Admittedly, this build-up of forced savings has the potential to boost consumption once restrictions are lifted and pent-up demand is released. But we have been sceptical that it will provide a significant boost to the recovery. (See here.) That has been supported by more recent analysis by French government researchers, which showed that most of last year’s additional savings accrued to the 20% wealthiest households, who are less likely to spend it all.

The week ahead

Next week, we expect to learn that euro-zone retail sales fell back in January, while the unemployment rate is likely to have remained stable. And February flash inflation numbers should show some reversal of the one-offs that pushed up the core rate at the start of the year.


Data Previews

Euro-zone Flash HICP (Feb.) Tue. 2nd Mar.

Forecasts

Time (GMT)

Previous

Median

Capital Economics

HICP m/m (y/y)

10.00

+0.2% (+0.9%)

(+1.1%)

+0.3%(+1.1%)

Core HICP m/m (y/y)

10.00

-0.5% (+1.4%)

+0.2%(+1.2%)

Core rate to fall in February, but then resume its rise

Core inflation will reverse some of last month’s increase in February. Over the rest of the year, however, we expect it to surprise on the upside.

Headline inflation was pushed up by energy prices in January, and energy inflation will increase much further in the coming months. But core inflation also rose in January, from a record low of +0.2% to +1.4%: by far the biggest jump on record.

Of that increase, 0.3%-points was due to delayed winter sales, which caused clothing and footwear inflation to rise. This should be reversed in February. (See Chart 2.) But global shortages of semi-conductors, plastics and shipping containers might put further upward pressure on other goods prices. And we expect services inflation to increase further, as package holiday inflation turns positive for the first time in a year and rising oil prices continue to push up the inflation rate of transport services.

We have pencilled in a fall in core inflation to 1.2% and an increase in headline rate to 1.1% in February. We then expect both to increase over the rest of the year, with headline inflation reaching 2% by May and exceeding the ECB’s target throughout H2.

Chart 2: Contribution of Clothing & Footwear to Headline HICP Inflation (Percentage Points)

Sources: Eurostat, Capital Economics

Euro-zone Composite PMIs (Feb.) Wed. 3rd Mar.

Forecasts

Time (GMT)

Previous

Consensus

Capital Economics

Spain

08.15

43.2

42.5

Italy

08.45

47.2

50.5

Easing of restrictions to boost Italy’s PMI

Italy’s PMI probably rose in February, but with restrictions now being tightened, any improvement will be short-lived.

The press release for February’s flash PMIs noted that outside of France and Germany, the PMI for the rest of the euro-zone rose but remained below 50.

We think this increase was probably driven by Italy. Virus restrictions were relaxed in many Italian regions at the start of February, which mobility data show has led to an increase in activity. And Italy’s economic sentiment indicator (ESI) rose sharply this month too. By contrast, Spain’s PMI is likely to have fallen, as mobility has been little changed while its ESI declined. (See Chart 3.)

Looking ahead, there are some signs that infections are rising in Italy, and the authorities are becoming increasingly worried about the UK variant. So we doubt that any pick-up in activity there will last.

Chart 3: Economic Sentiment Indicators

Source: Refinitiv

Euro-zone Retail Sales (Jan.) Thu. 4th Mar.

Forecasts

Time (GMT)

Previous

Median

Capital Economics

Euro-zone Retail Sales m/m (y/y)

10.00

+2.0%(+0.6%)

-2.0%(-1.5%)

-1.0%(-1.5%)

Proving resilient

Euro-zone retail sales are proving more resilient to virus restrictions than last spring but they still probably fell in January.

In December, euro-zone retail sales rose by 2% m/m. Sales jumped in France, where shops re-opened, but fell in Germany where they were shut.

We do not have much to go on for January. High frequency mobility data show that, after falling sharply in December, the number of retail and recreation trips plateaued last month. Shops remained open in France but were subject to an earlier curfew and timely data show that retail sales fell back. Meanwhile, shops in Spain were similarly subject to slightly tighter measures and shops in Madrid were shut due to snowstorm for a number of days. Meanwhile, non-essential retail was closed in Germany and the Netherlands, and for longer than in December, which suggests sales there fell too. Overall, we think that euro-zone retail sales might have fallen by about 1% m/m in January, leaving them below their pre-pandemic level. (See Chart 4.)

Looking ahead, retail sales are likely to remain relatively weak in the coming months. Substantial restrictions remain in place throughout the region even if some countries, such as the Netherlands, have announced easing measures from March.

Chart 4: Euro-zone Retail Sales (Feb. 2020 = 100)

Sources: Refinitiv, Capital Economics

EZ Unemployment Rate (Jan.) Thu. 4th Mar.

Forecasts

Time (GMT)

Previous

Median

Capital Economics

Euro-zone Unemp. Rate

10.00

8.3%

8.3%

8.3%

Holding steady

We think that the euro-zone unemployment rate held steady at the start of 2021, even as economic activity remained depressed.

The unemployment rate was on a steady downward trend in the second half of last year, from a peak of 8.7% in July to 8.3% in December. Based on the country data already published, we expect that it will have remained at that rate in January 2021. National data show falls in the number of people classified as out of work in most euro-zone countries last month. Overall, we expect that the total number of unemployed people will have declined by around 75,000 in January. But this will not have been large enough to cause the rate to decrease from 8.3%.

Looking ahead, though, hiring activity remains subdued (see Chart 5) and those out of work that have temporarily left the labour force during the lockdowns are likely to return. Once the economic recovery is underway, governments are also likely to start gradually tapering their short-time working schemes. Overall, we expect the unemployment rate to rise further in the coming six months or so and to peak just below 9% before gradually coming down.

Chart 5: EC Employment Intentions Index & Employment

Sources: Refinitiv, Markit, Capital Economics


Economic Diary & Forecasts

Upcoming Events and Data Releases

Date

Country

Release/Indicator/Event

Time CET

Time (GMT)

Previous*

Median*

CE Forecasts*

Mon 1st

Spa

Markit Manufacturing PMI (Feb)

09.15

(08.15)

49.3

52.0

Ita

Markit Manufacturing PMI (Feb)

09.45

(08.45)

55.1

57.0

EZ

Manufacturing PMI (Feb, Final)

10.00

(09.00)

57.5p

57.7

57.5

Ita

CPI (Feb, EU Harm., Prov.)

11.00

(10.00)

-1.1%(+0.2%)

Ita

Gov’t Deficit (2020, % of GDP)

12.00

(11.00)

1.6%

Ger

CPI (Feb, EU Harm., Prov.)

14.00

(13.00)

+1.4%(+1.6%)

+0.6%(+1.6%)

Tue 2nd

Ger

Retail Sales (Jan)

08.00

(07.00)

-9.1%(+2.8%)

+0.7%(+1.4%)

Ger

Unemployment Rate (Feb)

09.55

(08.55)

6.0%

6.0%

EZ

Flash CPI (Feb)

11.00

(10.00)

+0.2%(+0.9%)

(+1.1%)

(+1.1%)

EZ

Flash Core CPI (Feb)

11.00

(10.00)

(+1.4%)

(+1.2%)

Wed 3rd

Spa

Markit Composite PMI (Feb)

09.45

(08.45)

43.2

42.5

Ita

Markit Composite PMI (Feb)

09.50

(08.50)

47.2

50.5

Fra

Markit Composite PMI (Feb, Final)

09.50

(08.50)

45.2p

45.2

Ger

Markit Composite PMI (Feb, Final)

09.55

(08.55)

51.3p

51.3

51.3

Ita

GDP (Q4, Final, q/q(y/y))

10.00

(09.00)

-2.0%(-6.6%)p

-2.0%(-6.6%)

EZ

Markit Composite PMI (Feb, Final)

10.00

(09.00)

48.1p

48.1

48.1

EZ

ECB’s Schnabel participates in online panel

20.30

(19.30)

Thu 4th

Net

CPI (Feb, EU Harm.)

06.30

(05.30)

-0.7%(+1.6%)

EZ

Unemployment Rate (Jan)

11.00

(10.00)

8.3%

8.3%

8.3%

EZ

Retail Sales (Jan)

11.00

(10.00)

+2.0%(+0.6%)

-2.0%(-1.5%)

-1.0%(-1.5%)

EZ

Services Output (Q4 2020)

(11.00)

(10.00)

Fri 5th

Ger

Factory Orders (Jan)

08.00

(07.00)

-1.9%(+6.4%)

+1.1%

Ita

Retail Sales (Jan)

10.00

(09.00)

+2.5%(-3.1%)

Selected future data releases and events

Mon 8th

Ger

Industrial Production (Jan)

08.00

(07.00)

+0.0%(-1.0%)

Gre

GDP (Q4, q/q(y/y))

11.00

(10.00)

+2.3%(-11.7%)

Tue 9th

EZ

Employment (Q4, Final, q/q(y/y))

11.00

(10.00)

+0.3%(-2.0%)p

+0.3%(-2.0%)

EZ

GDP (Q4, Final, q/q(y/y)

11.00

(10.00)

-0.6%(-5.0%)p

-0.6%(-5.0%)

Thu 11th

EZ

ECB Interest Rate Announcement

(13.45)

(12.45)

-0.50%

-0.50%

*m/m(y/y) unless otherwise stated. p=provisional. Sources: Bloomberg, Capital Economics

Main Economic & Market Forecasts

%q/q(%y/y) unless stated

Latest

Q4 2020

Q1 2021

Q2 2021

Q3 2021

Q4 2021

2019

2020

2021

2022

GDP

-0.6(-5.0)

-0.6(-5.0)

-0.5(-1.8)

+1.4(+12.8)

+2.2(+2.4)

+1.1(+4.2)

+1.3

-6.8

+4.0

+4.0

Household Spending

+14.0(-4.6)

-2.5(-7.0)

-0.7(-3.4)

+2.5(+13.1)

+2.4(+1.6)

+1.8(+6.1)

+1.3

-7.9

+4.1

+4.8

HICP (%y/y)

+0.9 (Jan)

-0.3

0.9

1.6

1.8

2.2

+1.2

+0.3

+1.6

+0.7

Unemployment Rate (%)

8.3 (Dec)

8.4

8.6

8.8

8.6

8.4

7.6

8.0

8.5

8.0

Depo Rate, end period (%)

-0.50

-0.50

-0.50

-0.50

-0.50

-0.50

-0.50

-0.50

-0.50

-0.50

10yr Bund Yield, end period (%)

-0.25

-0.58

-0.27

-0.35

-0.42

-0.50

-0.19

-0.58

-0.50

-0.25

$/euro, end period

1.21

1.22

1.22

1.23

1.24

1.25

1.12

1.22

1.25

1.25

£/euro, end period

0.87

0.89

0.87

0.87

0.86

0.86

0.85

0.88

0.86

0.86

Sources: Bloomberg, Capital Economics


Jessica Hinds, Europe Economist, jessica.hinds@capitaleconomics.com