US GDP slump amp Eurozone CPI give Yellen Draghi more time

Today’s Eurozone inflation figures give more time for the ECB to monitor the effect of the longer-term price trend before resorting to further policy action, while the US Q1 GDP & ECI reports underline the disinflationary obstacles to hawkish interpretations that tapering could transition into tightening by end of Q1 2015.  

The advanced US Q1 GDP showed a 0.1% rise, the lowest since Q4 2012. The biggest losing contributors were mostly weather-related, with non-residential investment showing its first declining contribution since Q1 2013 and next export’s -0.83% was the first negative since Q2 2013.

Q1 Employment Cost Index dropped to 0.3% — the lowest since Q3 2011, but when unrounded, showed -0.25%, the lowest figure on record (in the index’s 32-year history).

The sobering ECI figures will cause the Fed to spill more ink on the inflation front and offer fresh light to Fed Chairman Yellen’s wondering as to why inflation is not higher than currently shown in present statistics.

Eurozone CPI keeps time on Draghi’s side

There are 2 ways to interpret today’s release of the 0.7% y/y rise in Eurozone flash April CPI:

-      The negative approach focuses on the failure to meet expectations for a 0.8% rise and that inflation remains below 1.0% for the 7^th consecutive month (longest period since the 2009 crisis)

-      The positive approach looks into the improvement from the 0.5% February and the 1% rise in core inflation (from a 4-year low of 0.7% in March). This is largely due to the stabilization in the energy price component to -1.2% in April from -2.1% in March.

Today’s figures are consistent with the ECB’s stance of preferring to wait for more evidence on whether the downside price risks would raise the deflationary flag, or ride out a time lag before inflation stabilizes higher.

ECB president Draghi said the following about the 0.5% rise in March inflation: “I tried to put these figures in perspective saying that we see no statistical or model based evidence of a self-feeding broad based falling of prices.  In other words we have no evidence that people are postponing spending waiting for lower prices…”

Following the release of the modest improvement in headline CPI and the jump in core prices, the ECB has more reasons to stick to its waiting game, while simultaneously discreetly talking down the currency by acknowledging its role in dampening inflation, rather than referring to the pace of its rise or to negative impact on corporate margins. In the event that CPI falls below 0.5% and remains below it by June, then ECB will likely to end up slashing rates by 10 bps in its refinancing rate. Persistent disinflationary worries into September would prompt a conditions-based LTRO3.

Today’s set of data underline our euro-positive stance and why the single currency could well regain the $1.3970-80 figure as long as the ECB refrains from slashing rates and the Fed deploys the necessary rhetoric to stem down bond yields despite its gradual tapering of asset purchases. In fact, the Fed may have to grow more dovish near end of Q2 as tapering leaves out fewer asset purchases and bond traders require higher yields.