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Eurozone: Fast Forward To Price Stability And Recession (powered by Bank of America) |
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31.10.08 12:41 |
| | | Eurozone: Fast Forward To Price Stability And Recession
In the wake of a recession, inflation usually goes down while unemployment goes up. This time, everything seems to happen faster. Inflation and the labour market have already turned down sharply even well before the hard data have confirmed that the economy has actually entered recession.
In October, inflation fell further to 3.2% from 3.6% in September, well below its 4.0% peak which in June and July had spooked the ECB into making a rather unwarranted rate hike. Inflation is now at its lowest level since January. Although the flash estimate contains no details, the prior national releases for Germany, Spain and Belgium and today's Italian data confirm that lower oil prices are the main driver.
The good inflation news will not stop here. The base effect from the 3.4% spike in energy prices last November will probably shave 0.3 points off headline inflation next month. Adding the most recent fall in oil prices and receding food price inflation to the mix, headline inflation could well be at 2.8% in November and December. At current oil prices, inflation could trough just below 1% in June and July next year before trending up thereafter as the base effects from the current decline in oil prices kick in. We would not be surprised if markets were to start discussing the risk of deflation soon although, in our view, any oil-driven decline in prices should be seen as a welcome economic stimulus rather than a threat.
Separately, the Eurozone labour market continues to go down. While the unemployment rate held steady at 7.5% in September, the number of jobless increased by 52k after a 100k increase in August. This brings the total cumulative rise in unemployment since the trough in March to 568k. Although the number of German jobless has fallen by 160k during this period according to separate German statistics, the bad news in Spain, Italy and - more recently - in France has more than offset this.
As the recession starts to bite, German unemployment looks set to rise by about 500k over the course of next year. With other countries of the Eurozone not in much better shape, we expect total Eurozone unemployment to increase by at least 1.5 million next year, pushing the unemployment rate from 7.5% now to 8.5% or slightly above in late 2009.
Beyond the near-term impact from falling oil prices, rising unemployment and falling rates of capacity utilisation look set to keep a firm lid on underlying inflation in the next two years. We expect the ECB to slash its 2008 and 2009 inflation forecasts (currently 3.5% and 2.6%) quite substantially upon presenting new staff estimates in December, possibly to a mere 2% for next year. At the same time, the ECB will probably publish a first 2010 forecast of no more than 1.8%.
The collapse in leading indicators and the apparent onset of recession amid a credit crunch argue for significantly lower ECB rates. The fall in headline inflation makes it easier for the ECB to agree on and explain such rate cuts. We look for the ECB to reduce rates by 50bp at its November meeting, and to follow up with a further 50bp cut no later than January. The chance that the ECB may make the follow-up easing move in December already continues to rise, in our view.
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