Gross Domestic Product for the last quarter of 2016 registered a positive 50 basis increase of the previous quarter and continued its positive trajectory from previous quarters. And with the string of data released so far, leading indicators are pointing towards a similar print for Q117.
Inflationary pressures continue to point northwards, albeit at a relatively moderate pace, so all eyes in the months to come are expected to be on wage growth, a key measure and one of the primary criteria which the European Central Bank continues to monitor closely and which forms an integral part of its policy in decision making. More importantly, we will be looking at real income and the possible extent to which real income could be possibly squeezed as a result of this mismatch.
The most recent inflationary headline print came in at 1.8% during January, up from 1.1% in the previous month, mainly on the back of higher commodity related prices, such as food and energy whilst core inflation stood at 0.9%. Having said that, there is expected to be some sort of spill over from higher energy prices so core inflation could well remain hovering around these levels, if not continue to creep upwards.
For there to be a meaningful uptick in core inflation, the structural effects of higher wage growth need to infiltrate into the economy first which could be one of the greatest breakthroughs impacting ECB monetary policy. At this juncture, we could only see this happening in a powerhouse such as Germany. Although we do not envisage this to occur imminently, we do not exclude 2017 being a transitory year for the ECB and its accommodative monetary policy stance, which, always dependent on income economic data, could well be tweaked towards the course of the next 12 months.
The ECB and its officials will be scratching their heads as to what to do next, what to communicate to the media and to the markets, and more importantly, what stance to take on their ultra-accommodative monetary policy stance, which, following the recent string of positive data, primarily inflation, places doubt on the need to maintain such a stance for much longer. Or at least, the extent of accommodation could be challenged once again and tweaked in the months to come. True, during the January press conference, ECB’s Draghi said yet again that it would need to be reassured that inflation ought to be ‘durable’, ‘self-sustained’ and ‘relevant’ for the single currency region in order to justify another shift from the monthly asset purchase reduction announced just last December.
Rate hikes are premature to predict. Additional reduction in asset purchases will happen but we don’t know when. But what is sure that the markets are moving, and pricing in scenarios which include higher inflation as the movements we have seen so far in the European sovereign yield curve in 2017 continue to point in this direction. Interest rates are up, with the Benchmark 10-Year German Bund up from 0.20% to 0.42% in just 5 weeks, and the negative performance witnessed in the European sovereign bond market in the last quarter reverberated in January, particularly the longer-dated bonds and hence those bonds highly exposed to interest rate and more susceptible to moves in interest rates. Is this a trend which is expected to persist in the months?
This could very well be the case, particularly if inflationary pressures persist and are, as ECB’s Draghi puts it, sustainable. So at this point, we cannot but stress the importance of having adequately exposed portfolios and to try, as much as possible, limit exposures to interest rate risk.
Disclaimer: This article was issued by Mark Vella, Investment Manager at Calamatta Cuschieri. For more information visit, www.cc.com.mt.The information, views and opinions provided in this article are being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice. Calamatta Cuschieri Investment Services Ltd has not verified and consequently neither warrants the accuracy nor the veracity of any information, views or opinions appearing on this website.