The Euro area is facing contagion from the US bond market reacting to the Biden plan in the form of higher real rates. Now, some overheating in the US may be in the ECB’s interest if it triggers some Euro depreciation 1/6
What happens if the Fed opts for “quick tapering” and US 10y yields go to 3% by 2022? In our model this would take the Euro down 10% against the dollar after 1y relative to the ECB’s baseline. That could bring EA inflation to 1.9% in 2023 from 1.4% in baseline 2/6
BUT it works only if the ECB is active in fighting “market-led tightening in financing conditions”. First because Euro will weaken only if the IR spread widens, and second because the impact of lower Fx on inflation will be lost if the output gap is too big 3/6
Out of the 6 episodes of 2-digit Euro depreciation since 1999, inflation ended up DECELERATING a year later in 3 cases, and in the remaining cases inflation accelerated less than implied by the ECB model 4/6
Capacity underutilisation can completely drown the effect of higher import prices on inflation. To be able count on FX to help fulfill its inflation target, the ECB can’t be passive 5/6
PEPP numbers will be crucial in the coming weeks. Full musings here… 6/6

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More from @MoecGilles

23 Sep 20
Fabio Panetta’s speech could well be the beginning of the ECB’s response to the Fed’s Average Inflation Targeting - assuming it is embraced by the rest of the Governing Council 1/9
The Fed’s move is based on the notion that it is easier to allow inflation to overshoot in the future amid decent cyclical conditions than to lift infla amid bad cyclical conditions. A pledge to overshoot tomorrow is thus credible and could lift inflation expectations today 2/9
A drawback of AIT is that it can send a signal of powerlessness today, or even justify a certain immobilism in the short run: “since I promised something for the future, don’t ask me to do more today” 3/9
Read 9 tweets
7 Sep 20
It’s a swoosh! The global data flow continues to point upward but the pace of normalisation is slowing down. See for instance the deceleration in US private payroll growth and retreat in Euro area PMIs (although still in expansion territory 1/8
This calls for policy support beyond the emergency packages. The French recovery plan participates to this. But at the same time we are surprised by fiscally disciplinarian noises emerging here and there 2/8
The UK is breaking ranks with a debate heating up on tax hikes next year already. We interpret this as the concerns in some segments of the UK government about the status of the UK in international markets post hard Brexit 3/8
Read 8 tweets
21 Jul 20
It’s always pleasing to see the British Eurosceptic press defeated again: habemus RRF deal! Rumours of the EU’s death were exaggerated as usual 😊 1/8
Now, on substance, the signals are very positive. The taboo of debt mutualisation is broken. Financial solidarity that does not saddle recipients with more debt is an important political moment 2/8
However, with the grants reduced, and the inherently slow disbursement schedule, the RRF is no macroeconomic game-changer 3/8
Read 8 tweets
8 Jul 20
The pandemic acceleration/stimulus debate loop has started again in the US. Real-time data is starting to reflect a relapse in activity. Pumping up more pent-up household demand may not be the solution though 1/11
The HEROES act passed by the House in May legislates for an even more generous “check” to households (4800 USD for a family of 4 instead of 3400). D.Trump signalled openness to make it even bigger 2/11
Still, as of May, total household income was already 3.8% > the pre-pandemic level. The drop in labour income is more than offset by the rise in transfers (even if many families fall through the safety net) 3/11
Read 11 tweets
30 Jun 20
Assuming our economies continue to normalise fairly swiftly (which in Europe remains the likely scenario) fiscal policy should shift from emergency “carpet bombing” offsetting the collapse in supply to long-haul demand management 1/11
However industries/businesses were not equal in the face of the lockdown and some of them will need specific protection for long. This is triggering a debate on over-protection/zombification. We think however that sectoral support is part of demand management. 2/11
The new long term part-time unemployement scheme unveiled in France will offer up to 2 years relief to badly hit firms through up to 40% working time reduction subsidized to the tune of 80-85% by the government. More than 25% of their employees pay would be socialised 3/11
Read 11 tweets
23 Jun 20
A 1% decline in GDP triggers a 6% rise in the non-performing loans ratio. This matters for the public debt trajectory given the size of the loan guarantees offered to deal with the pandemic in some countries 1/9
In the case of Italy, the impact of the ongoing recession would be consistent with 13% of loans turning “delinquent”. With an average guarantee of 80% if all the envelope is used, this could add another 2.5% of GDP to the deficit 2/9
But more fundamentally, this would add to the risk of a premature fiscal consolidation being ultimately counterproductive 3/9
Read 9 tweets

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