Investment Research General Market Conditions 6 March 2015 Euro Inflation Research #2 ECB s core inflation forecast is too optimistic The ECB yesterday published new inflation forecasts, including the first projection for 2017, and the ECB expects inflation to increase to close to 2%. The forecast for 2016 was, somewhat surprisingly, raised from 1.3% to 1.5%, probably reflecting the ECB expecting the QE programme to support inflation. Related to this, the new forecast includes the added impact of the non-standard monetary policy, which is not normally captured by the modelling framework. The ECB expects core inflation to increase above the historical average in 2017. The increase should be seen in light of a projected increase in wage growth. We see this as too optimistic, as the ECB expects only a gradual decline in the unemployment rate and there is a large amount of slack in the labour market. In the US, wage inflation remains subdued despite a rapid improvement in the unemployment rate following the recession. The ECB expects inflation close to 2% in 2017 The ECB s new inflation forecasts released yesterday showed that the ECB expects inflation to increase to below, but close to, 2% at the end of the forecast horizon, as it looks for inflation of 1.8% in 2017. The increase is driven mainly by higher core inflation. Euro inflation research This is the second paper in our series about inflation in the euro area. See also the following. Euro Inflation Research No. 2: Inflation to increase sharply this year, 5 March ECB s projection is above consensus Euro area 2015 2016 2017 forecasts GDP HICP GDP HICP GDP HICP Danske Bank 1.5 0.1 2.0 1.5 2.2 1.6 Consensus 1.2-0.1 1.6 1.2 1.5 1.45 ECB 1.5 0.0 1.9 1.5 2.1 1.8 Source: Bloomberg, ECB, Danske Bank Markets Added to this, the ECB revised its inflation forecast higher for the first time in more than a year. In 2016, the ECB expects inflation of 1.5%, up from a forecast of 1.3% in the December staff projection. It is likely the revised inflation forecast reflects the new forecast including the additional impact of the non-standard monetary policy measures, which is not usually captured by the ECB s standard modelling framework. ECB revised its forecast for 2016 higher and expects inflation close to 2% in 2017 Source: ECB, Danske Bank Markets Senior Analyst Pernille Bomholdt Nielsen +45 45 13 20 21 perni@danskebank.dk Important disclosures and certifications are contained from page 4 of this report. www.danskeresearch.com
The ECB is too optimistic on its core inflation forecast The ECB expects core inflation to increase to 1.7% in 2017, which is above the historical average of around 1.5%. The ECB s forecast is above our forecast and in 2015-16 the ECB s core inflation projection is higher than our expectation. ECB s inflation forecast in 2017 is optimistic... mainly because of a too-optimistic core inflation forecast We believe the ECB s high core inflation forecast is due mainly to a projected increase in wage growth over the forecast horizon. The ECB argues this is driven by ongoing employment growth and some decline in the unemployment rate but we see this as too optimistic, as the unemployment rate is expected to decline only gradually and there is a large amount of slack in the labour market, which, in our view, will keep wage growth very subdued. Compared with the US, wage inflation remains subdued despite a rapid improvement in the unemployment rate following the recession. ECB forecasts higher wage growth this year We expect economic slack to keep wage growth subdued Source: ECB, Danske Bank Markets Source: Bureau of Labour Statistics, ECB, Eurostat, Danske Bank Markets Part of this is also likely to reflect the expected impact of monetary policy easing, which is incorporated in the new projection from the ECB. Including this is likely to imply a smaller downward impact from the second-round effects on wages of the sharp fall in the oil price. According to the ECB, it expects limited second-round effects due to downward rigidities in wages and since the impact via automatic wage indexation systems should be small. We believe wages are likely to follow inflation and inflation expectations lower due to both wage indexation and lower negotiated wages, as the low inflation makes it easier for employers to argue for low nominal wage growth. 2 6 March 2015 www.danskeresearch.com
Upward sloping inflation forecast due to oil prices In line with our expectation, the ECB expects a sharp increase in inflation at the end of this year and the beginning of 2016. In Q3 15, the ECB expects inflation around 0.0% and in Q1 16 it projects it will increase to above 1.0%, before reaching 1.5% in Q2 16. According to the ECB, this should be the case due to the combination of the fading of the significant downward effects of the past declines in oil prices together with the upward effects of the assumed increases in oil prices (based on the upward sloping oil price futures curve) ECB expects a sharp increase in inflation......as the downward effect of the past oil price decline fades Source: Bloomberg, ECB, Danske Bank Markets Based on the oil price futures curve, the ECB forecasts energy price inflation will average -6.5% in 2015 and increase to +2.3% in 2016, before declining a bit in 2017. This is below our forecast for energy price inflation but could reflect the ECB s cut-off date of 11 February. Following the cut-off date, the inflation figure for February surprised on the upside, due mainly to higher commodity price inflation and, based on this, we have revised our inflation forecast for 2015 higher. In terms of food price inflation, the ECB expects it to increase over the forecast horizon. Its projection is above our forecast, particularly for 2016-17. This could be because we expect weak price pressure to limit the spillover from higher global food prices, as our forecasts for global food prices are close to or above the prices in the forward market. ECB s energy price inflation projection below our expectation ECB s food price inflation projection is above our forecast Source: ECCB, Eurostat, Danske Bank Markets 3 6 March 2015 www.danskeresearch.com
Disclosures This research report has been prepared by Danske Bank Markets, a division of Danske Bank A/S ( Danske Bank ). The author of this research report is Pernille Bomholdt Nielsen, Senior Analyst. Analyst certification Each research analyst responsible for the content of this research report certifies that the views expressed in this research report accurately reflect the research analyst s personal view about the financial instruments and issuers covered by the research report. Each responsible research analyst further certifies that no part of the compensation of the research analyst was, is or will be, directly or indirectly, related to the specific recommendations expressed in the research report. Regulation Danske Bank is authorised and subject to regulation by the Danish Financial Supervisory Authority and is subject to the rules and regulation of the relevant regulators in all other jurisdictions where it conducts business. Danske Bank is subject to limited regulation by the Financial Conduct Authority and the Prudential Regulation Authority (UK). Details on the extent of the regulation by the Financial Conduct Authority and the Prudential Regulation Authority are available from Danske Bank on request. The research reports of Danske Bank are prepared in accordance with the Danish Society of Financial Analysts rules of ethics and the recommendations of the Danish Securities Dealers Association. Conflicts of interest Danske Bank has established procedures to prevent conflicts of interest and to ensure the provision of highquality research based on research objectivity and independence. These procedures are documented in Danske Bank s research policies. Employees within Danske Bank s Research Departments have been instructed that any request that might impair the objectivity and independence of research shall be referred to Research Management and the Compliance Department. Danske Bank s Research Departments are organised independently from and do not report to other business areas within Danske Bank. Research analysts are remunerated in part based on the overall profitability of Danske Bank, which includes investment banking revenues, but do not receive bonuses or other remuneration linked to specific corporate finance or debt capital transactions. Financial models and/or methodology used in this research report Calculations and presentations in this research report are based on standard econometric tools and methodology as well as publicly available statistics for each individual security, issuer and/or country. Documentation can be obtained from the authors on request. Risk warning Major risks connected with recommendations or opinions in this research report, including a sensitivity analysis of relevant assumptions, are stated throughout the text. Date of first publication See the front page of this research report for the date of first publication. General disclaimer This research has been prepared by Danske Bank Markets (a division of Danske Bank A/S). It is provided for informational purposes only. It does not constitute or form part of, and shall under no circumstances be considered as, an offer to sell or a solicitation of an offer to purchase or sell any relevant financial instruments (i.e. financial instruments mentioned herein or other financial instruments of any issuer mentioned herein and/or options, warrants, rights or other interests with respect to any such financial instruments) ( Relevant Financial Instruments ). The research report has been prepared independently and solely on the basis of publicly available information that Danske Bank considers to be reliable. While reasonable care has been taken to ensure that its contents are not untrue or misleading, no representation is made as to its accuracy or completeness and Danske Bank, its affiliates and subsidiaries accept no liability whatsoever for any direct or consequential loss, including without limitation any loss of profits, arising from reliance on this research report. The opinions expressed herein are the opinions of the research analysts responsible for the research report and reflect their judgement as of the date hereof. These opinions are subject to change and Danske Bank does not undertake to notify any recipient of this research report of any such change nor of any other changes related to the information provided in this research report. 4 6 March 2015 www.danskeresearch.com
This research report is not intended for retail customers in the United Kingdom or the United States. This research report is protected by copyright and is intended solely for the designated addressee. It may not be reproduced or distributed, in whole or in part, by any recipient for any purpose without Danske Bank s prior written consent. Disclaimer related to distribution in the United States This research report is distributed in the United States by Danske Markets Inc., a U.S. registered broker-dealer and subsidiary of Danske Bank, pursuant to SEC Rule 15a-6 and related interpretations issued by the U.S. Securities and Exchange Commission. The research report is intended for distribution in the United States solely to U.S. institutional investors as defined in SEC Rule 15a-6. Danske Markets Inc. accepts responsibility for this research report in connection with distribution in the United States solely to U.S. institutional investors. Danske Bank is not subject to U.S. rules with regard to the preparation of research reports and the independence of research analysts. In addition, the research analysts of Danske Bank who have prepared this research report are not registered or qualified as research analysts with the NYSE or FINRA but satisfy the applicable requirements of a non-u.s. jurisdiction. Any U.S. investor recipient of this research report who wishes to purchase or sell any Relevant Financial Instrument may do so only by contacting Danske Markets Inc. directly and should be aware that investing in non- U.S. financial instruments may entail certain risks. Financial instruments of non-u.s. issuers may not be registered with the U.S. Securities and Exchange Commission and may not be subject to the reporting and auditing standards of the U.S. Securities and Exchange Commission. 5 6 March 2015 www.danskeresearch.com