By David J. Powell, author of The Trader’s Guide to the Euro Area
A deceleration of inflation is likely to eventually force the European Central Bank to ease monetary conditions again and maintain loose policy for the foreseeable future.
Inflation in the euro area is trending downward. The headline HICP reading fell to 0.7 percent year over year in October from 1.1 percent in September. It has declined from a recent peak of 3 percent in November 2011.
The latest inflation data revealed the Governing Council is significantly undershooting its target. The ECB “aims to maintain inflation rates below, but close to, 2 percent over the medium term.”
Inflation has also been weaker than forecast by the staff economists. They projected in September an HICP inflation reading of 1.5 percent for 2013 and 1.3 percent for 2014.
Updated forecasts will be published in December. Estimates for GDP and inflation produced jointly by “experts from the ECB and from the euro area national central banks” are released biannually in June and in December. The ECB staff “complements” those projections with updates in March and in September.
The core reading paints an equally grim picture. It declined to 0.8 percent year over year in October from 1 percent in September. It peaked most recently in July 2012 at 1.7 percent. The core figure measures inflation inertia.
Lending data give reason for concern as well. Loans to non-financial corporations, adjusted for sales and securitization, fell 2.7 percent year over year in September versus minus 2.9 percent in August. The equivalent figure for households stood at 0.3 percent year over year, unchanged from the previous month.
That has caused the ECB to veer from the aims of the second pillar of its monetary-policy strategy as well. The three-month average of M3 money supply growth fell to 2.2 percent year over year in September from 2.3 percent in August. Those figures compare with the central bank’s “reference rate” of 4.5 percent.
Slack in the economy is likely to continue weighing on inflation. The unemployment rate remained at a record high of 12.2 percent in September. The OECD estimates the non-accelerating inflation rate of unemployment for the region to be 9.8 percent.
The recovery appears too weak to counter that problem. The level of GDP is still about 3 percent below its pre-crisis peak.
The euro-area economy emerged from recession during the second quarter of this year. It grew 0.3 percent quarter over quarter. The increase in total output followed six consecutive quarters of contraction. The year-over-year figure stood at minus 0.6 percent
A Taylor Rule model suggests easing is required to nurture the recovery. The monetary policy tool, based on coefficients estimated by the Federal Reserve Bank of San Francisco, suggests the one-week refinancing rate should be reduced to minus 0.25 percent. That compares with the present level of 0.25 percent. The signal is the result of low core inflation and high unemployment.
The hawks on the Governing Council have latched on to signs of recovery to oppose additional easing. The two best coincident indicators of GDP growth – the PMI surveys and industrial production – have provided them with some support.
The composite PMI survey suggests the expansion continued during the third quarter. The headline reading stood above 50 during July, August and September. It also remained above that threshold during the first month of the fourth quarter. The PMI surveys are the timeliest indicators of the present state of the economy and among the first monthly economic indicators released.
Industrial production data paints a similar picture. The index rose 1 percent month over month in September, though the year-over-rate registered minus 2.1 percent.
Industrial production provides a good indicator of overall GDP. A regression of industrial production growth on a quarter-over-quarter basis on GDP in the same form suggests that it explains 64 percent of the variation in overall output using data from the first quarter of 1995 to the second quarter of 2013.
The German Ifo survey – a leading indicator – also provides reason for optimism. The expectations component rose to 103.6 in October from a recent trough of 93.3 in September 2012.
The Ifo survey has been a good indicator of the euro-area economy as a whole, though the survey is only based on feedback from companies in Germany, the continent’s largest economy. The quarterly average of the expectations component of the survey tends to lead the year-over-year rate-of-change of euro-area GDP by three to six months. When the publishing lag is included, the lead is about four to seven months.
The German ZEW survey is sending a similar signal. The expectations component rose to 52.8 in October – the highest level since April 2010 – from a recent trough of minus 55.2 in November 2011.
The survey has also been a good indicator of the euro-area economy as a whole, though it is only based on feedback, with a few exceptions, from financial analysts in Germany. The quarterly average of the expectations component of the ZEW survey is most highly correlated with year-over-year euro-area GDP growth with a lead of three quarters.
Real M1 money supply growth is also signaling a recovery. The latest year-over-year figure – for the month of September – stood at 5.5 percent. That compares with a recent trough of minus 1.4 percent in June 2011. Real M1 money supply growth is the indicator of economic growth that provides the longest lead. It leads GDP growth by about four quarters.
The system of “consensus” building used by the Governing Council has allowed dissenters to squash the will of the majority. For example, most of the body’s members wanted to reduce the main policy rate of the ECB in December 2012 and the move was reportedly blocked by President Mario Draghi and Executive Board members Benoit Coeure and Joerg Asmussen as well as Bundesbank President Jens Weidmann.
The system still appears to allow the president to impose his will on the Governing Council by only selectively proposing a vote on matters of monetary policy. For example, in August 2012, Draghi appeared to suggest that he would overcome the opposition of Weidmann to the purchase of government bonds by having the latter outvoted.
Draghi appears to have repeated that act at the meeting in November. He will probably find himself in a similar position in the months – and possibly even years – to come.
About the Author:
David J. Powell is the author of The Trader’s Guide to the Euro Area: Economic Indicators, the ECB and the Euro Crisis. He is an economist at Bloomberg LP in London where he focuses on euro-area economics and currencies. Previously, he worked at Bank of America – Merrill Lynch as a currency strategist. He holds a master’s degree from the London School of Economics and Political Science, where he wrote his dissertation on the creation of monetary union in Europe, and a bachelor’s degree from New York University.
The Trader’s Guide to the Euro Area: Economic Indicators, the ECB and the Euro Crisis is published by Bloomberg, an imprint of Wiley, priced £29.99.
Barclays announces new trade finance platform for corporate clients
Barclays Corporate Banking has today announced that it is working with CGI to implement the CGI Trade360 platform. This new platform will provide an industry leading end-to-end global trade finance solution for Barclays clients in the UK and around the world.
With the CGI Trade360 platform, Barclays will provide clients with greater connectivity and visibility into their supply chains, allowing them to optimise working capital efficiency, funding and risk mitigation. By utilising cloud based functionality for corporate banking clients, Barclays will also be able to offer a leading client user experience through easy access and real-time integration to essential information, combined with the latest trade solutions as the industry-wide shift to digitisation continues to accelerate.
This move underpins Barclays commitment to supporting the trade and working capital needs of their clients and reinforces a commitment to innovation that has been central to the bank for more than 300 years.
James Binns, Global Head of Trade & Working Capital at Barclays, said: “We are delighted to announce our move to the CGI Trade360 platform and to have started the implementation process. We have a longstanding partnership with CGI, and the CGI Trade360 platform will mean we can continue delivering the best possible trade solutions and service to our clients for many years to come.”
Neil Sadler, Senior Vice President, UK Financial Services, at CGI, said: “Having worked closely with Barclays for the last 30 years, we knew we were in an excellent position to enhance their systems. Not only do we have a history with them and understand how they work, but part of the CGI Trade360 solution includes a proof of concept phase, which is essentially seven weeks of meetings and workshops with employees across the globe to guarantee the product’s efficiency and answer all queries. We’re delighted that Barclays chose to continue working with us and look forward to supporting them over the coming years.”
What’s the current deal with commodities trading?
By Sylvain Thieullent, CEO of Horizon Software
The London Metal Exchange (LME) trading ring has been the noisy home of metals traders buying and selling for over a hundred years. It’s the world’s oldest and largest metals market and is home to the last open outcry trading floor. Recently however, the age-old trading ring, though has been closed during the pandemic and, just a few weeks ago, the LME announced that it will remain so for another six months and that it is taking steps to improve its electronic trading. This news fits in with a growing narrative in commodities about a shift to electronic trading that has been bubbling away under the surface.
Something certainly is stirring in commodities. The crisis has affected different raw materials differently: a weakening dollar and rising inflation risks bode well for some commodities with precious metals being very attractive, as seen by gold reaching all-time highs. Oil on the other hand has had a tough year and experienced record lows from the Saudi-Russia pricing war. It has been a turbulent year, and now prices look set to soar. While a recent analyst report from Goldman Sachs predicts a bullish market in commodities for the year ahead, with the firm forecasting that it’s commodities index will surge 28%, led by energy (43%) and precious metals (18%).
Increasingly, therefore, it seems that 2020 is turning out to be a watershed moment for commodities, and it’s likely that the years ahead will bring about significant transformation. And whilst this evolution might have been forced in part by coronavirus, these changes have been building up for some time. Commodities are one of the last assets to embrace electronic trading; FX was the first to take the plunge in the 90s, and since then equities and bonds have integrated technology into their infrastructure, which has steadily become more advanced.
The slow uptake in commodities can be explained by several truths: the volumes are smaller and there is less liquidity, and the instruments are generally less exotic, essentially meaning it has not been essential for them to develop such technology – at least not until now. This means that, for the most part, the technology in commodities trading is a bit outdated. But that is changing. Commodities trading is on the cusp of taking steps towards the levels of sophistication in trading as we see in other asset classes, with automated and algo trading becoming ever prominent.
Yet, as commodities trading institutions are upgrading their systems, they will be beginning to discover the extent of the job at hand. It’s no easy task to upgrade how an entire trading community operates so there’s lots to be done across these massive organisations. It requires a massive technology overhaul, and exchanges and trading firms alike must be cautious in the way they proceed, carefully establishing a holistic, step-by-step implementation strategy, preferably with an agile, V-model approach.
The workflow needs to be upgraded at every stage to ensure a smooth end-to-end trading experience. So, in replacement of the infamous ring, these players will be looking to transform key elements of their trading infrastructure, including re-engineering of matching engines and improving communications with clearing houses.
However, these changes extend beyond technology. For commodities players to make a success of the transformation in their community, exchanges need to have highly skilled technology and change the very culture of trading. All of which is currently being done against a backdrop of lockdown, which makes things much more difficult and can slow down implementation.
What is clear is that coronavirus has definitely acted as a catalyst for a reformation in commodities. It is a foreshadowing of what lies ahead for commodities trading infrastructure because, a few years down the line, commodities trading could well be very different to how it is now, and the trading ring consigned to history.
Afreximbank’s African Commodity Index declines moderately in Q3-2020
African Export-Import Bank (Afreximbank) has released the Afreximbank African Commodity Index (AACI) for Q3-2020. The AACI is a trade-weighted index designed to track the price performance of 13 different commodities of interest to Africa and the Bank on a quarterly basis. In its Q3-2020 reading, the composite index fell marginally by 1% quarter-on-quarter (q/q), mainly on account of a pull-back in the energy sub-index. In comparison, the agricultural commodities sub-index rose to become the top performer in the quarter, outstripping gains in base and precious metals.
The recurrence of adverse commodity terms of trade shocks has been the bane of African economies, and in tracking the movements in commodity prices the AACI highlights areas requiring pre-emptive measures by the Bank, its key stakeholders and policymakers in its member countries, as well as global institutions interested in the African market, to effectively mitigate risks associated with commodity price volatility.
An overview of the AACI for Q3-2020 indicates that on a quarterly basis
- The energy sub-index fell by 8% due largely to a sharp drop in oil prices as Chinese demand waned and Saudi Arabia cut its pricing;
- The agricultural commodities sub-index rose 13% due in part to suboptimal weather conditions in major producing countries. But within that index
- Sugar prices gained on expectations of firm import demand from China and fears that Thailand’s crop could shrink in 2021 following a drought;
- Cocoa futures enjoyed a pre-election premium in Ghana and Côte d’Ivoire, despite the looming risk of bumper harvests in the 2020/21 season and the decline in the price of cocoa butter;
- Cotton rose to its highest level since February 2020 due to the threat of storm Sally on the US cotton harvest, coupled with poor field conditions in the US;
- Coffee rose 10% as La Nina weather conditions in Vietnam, the world’s largest producer of Robusta coffee, raised the possibility of a shortage in exports.
- Base metals sub-index rose 9% due to several factors including ongoing supply concerns for copper in Chile and Peru and strong demand in China, especially as the State Grid boosted spending to improve the power network;
- Precious metals sub-index, the best performer year-to-date, rose 7% in the quarter as the demand for haven bullion continued in the face of persistent economic challenges triggered by COVID-19 and heightening geopolitical tensions. In addition, Gold enjoyed record inflows into gold-backed exchange traded funds (ETFs) which offset major weaknesses in jewellery demand.
Regarding the outlook for commodity prices, the AACI highlights the generally conservative market sentiment with consensus forecasts predicting prices to stay within a tight range in the near term with the exception of Crude oil, Coffee, Crude Palm Oil, Cobalt and Sugar.
Dr Hippolyte Fofack, Chief Economist at Afreximbank, said:
“Commodity prices in Q3-2020 have largely been impacted by COVID-19. The pandemic has exposed global demand shifts that have seen the oil industry incur backlogs and agricultural commodity prices dwindle in the first half of the year. The outlook for 2021 is positive however conservative the markets still are. We hope to see an increase in global demand within Q1 and Q2 – 2021 buoyed by the relaxation of most COVID-19 disruptions and restrictions.’’
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