ECB worried of higher inflation

(03.02.2011) The U.S. dollar recovered slightly versus the euro yesterday, after several days with euro strengthening. The ECB’s policy meeting will attract attention today, as the central bank already has taken a hawkish note after the recent spike in headline inflation.

By Anders Grøn Kjelsrud, Analyst at DNB Markets

dealingrrom DNB marketsIn FX, the dollar has gained almost 0.5 per cent versus the euro since yesterday morning. The weaker euro could probably be related to both the S&P’s downgrading of Ireland and better-than-expected figures from the U.S. labor market. The ADP survey, issued yesterday, suggests that private sector employment rose by 187.000 in January – better than expected beforehand (145.000), but weaker than the revised increase of 247.000 in December. The encouraging figure last month was not in accordance with the more comprehensive non-farm payrolls data. The correlation between the two different set of surveys has generally been fairly weak during the last year. The real question then, is how much one should emphasize yesterday’s positive report in advance of the more important payrolls figures, which are due tomorrow. We, at least, still expect that non-farm payrolls rose by only 80’ in January.

The ECB will announce its latest interest rate decision later today. The refi rate will most certainly remain at 1 per cent – the focus will instead be on which signals the central bank gives regarding future interest rates. High and rising food and energy prices have pushed up headline inflation in several areas, including in the euro zone. According to the flash estimate, released Monday, the overall consumer prices rose by 2.4 per cent in the twelve months to January. This was the second consecutive month where CPI inflation came out higher than the ECB’s target (below, but close to 2 per cent). Yesterday, new figures suggested that the producer prices rose by an annual rate of 5.3 per cent in December, up from 4.5 per cent in November and doing little to ease the central bank’s inflation fears. Still, underlying inflation remains subdued, as unemployment is record high and the economy has plenty of spare capacity. Given the high rate of unemployment, we doubt that the employers are in any position to demand compensation for increased expenses on food and energy. If that turns out correctly, the recent upturn in these prices will instead work out as a “consumption tax”, effectively reducing household’s disposable income, and hence, dampen the price pressure in the medium term. By face value, this suggests that the central bank should keep the interest rate low even longer.

However, the ECB has previously been very wary of inflation above target. Last month Jean-Claude Trichet adopted a distinctly more hawkish tone, and among other things cited the rate hike in 2008 when inflation had reached 4 per cent, but the economy already was in recession. He also stressed the distinction between ECB’s conventional and unconventional policy, with the aim of pointing out that the interest rates could be increased to tame inflation while at the same time the extraordinary liquidity measures continues. As CPI inflation has surged even further since the last policy meeting, Trichet is not likely to take a less aggressive tone at today’s meeting. Nevertheless, we still believe the ECB will have to keep their key interest rate on hold until well into 2012, due to few signs of improvements in the labor market and fiscal tightening, which is likely to hamper the recovery. Admittedly, further increases in commodity prices constitutes a clear upside risk to this interest rate forecast.

In Norway, the latest Labour Force Survey from Statistics Norway suggested that the unemployment rate remained unchanged at 3.6 per cent in November (average Oct-Dec) – in line with the expectations beforehand. However, the number of unemployed persons increased from 92' to 94'. From Q3 to Q4 the unemployment ratio increased 0.2 percentage points or 5' persons. Employment increased by 6' persons from October to November, after an increase of 7' the previous month. The labour force increased by 8' persons. Hence, unemployment increased by 2' persons. In all, the development in the labour market seems quite stable, and is well in line with Norges Bank's estimate of a 3.5 per cent unemployment rate in 2010. The Norwegian krone was little changed after the report, and is currently traded roughly at the same level as yesterday morning versus the euro.