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EMU: Growth now, stability later...

Thu, Nov 20 2008, 10:42 GMT
by Yapi Kredi Bank Economic Research Department

UniCredit Group

● The dramatic worsening of the growth outlook throughout the eurozone has strengthened the call for fiscal stimulus, particularly suited to support activity at a time in which monetary policy risks being less effective than usual.

● Next year, budget deficits in the area’s largest economies will increase significantly, due to the effect of both automatic stabilizers and discretionary fiscal measures. A generalized breach of Maastricht criteria is in the cards, but we don’t see this as a negative factor.

● Under the current exceptional circumstances, avoiding a major economic slump is certainly the main priority. What truly matters is that individual countries adopt a cooperative rather than opportunistic behavior not only when passing looser policies, but also when things will start to improve.

● Higher budget deficits will have a major impact on bond issuance in 2009. In a best-case scenario, we expect gross supply in the eurozone to amount to EUR 818bn, posting a EUR 179bn increase vs. 2008. In a worst-case scenario, bond issuance would surpass a record amount of EUR 1tn, more than a 50% increase vs. 2008

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Published on  Thu, Nov 20 2008, 10:42 GMT

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Introducing persistence in EMU inflation analysis

Thu, Sep 25 2008, 12:02 GMT
by Yapi Kredi Bank Economic Research Department

UniCredit Group

• ● We add a new tool to our inflation-watch instruments for the euro area: a persistence-weighted (PW) measure of core inflation. 

• ● Contrary to standard measures of core inflation that strip out the most erratic and volatile components, PW core inflation gives more weight to the items of the HICP basket displaying a higher degree of persistence. 

• ● This methodology delivers a core measure that allows capturing the more lasting component of price increases. Therefore, the PW core inflation provides some important information for the conduct of monetary policy, even though headline HICP remains the single most important consumer price gauge to which the ECB reacts. 

• ● Starting in late-summer 2007, PW core inflation has shown a strong acceleration that helps understand why the ECB hiked interest rates in July despite mounting evidence of slowing growth and the fact that traditional measures of core inflation appeared generally well behaved.

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Published on  Thu, Sep 25 2008, 12:02 GMT

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Eurozone Insight

Tue, Aug 5 2008, 14:31 GMT
by Yapi Kredi Bank Economic Research Department

UniCredit Group

• ● The last two ECB meetings have resulted in the largest bond sell-off (June 5) and the largest bond rally (July 3) ever occurred on the day of a regular Governing Council meeting.

• ● This has brought the issue of communication back to the fore, ending the two-year long honeymoon between the ECB and the markets and bringing back visions of the bad old times when a disconnect between the central bank and market players seemed to be the rule. 

• ● The analysis developed in this paper casts some interesting light on central bank communication and on its nature, purpose, and pitfalls. The main conclusion of the analysis in our view are as follows: 

• ● Central bank communication is an ongoing effort to gradually educate market participants on how the bank processes and reacts to macroeconomic data: communication gradually reveals the core of the policy reaction function. For the ECB we have shown that this is indeed the case. 

• ● Data, and not words will be the main market movers in normal times. However, communication is crucial when there is a change in the policy reaction function. This in our view is exactly what happened in June. The abrupt market reaction indicates that the change in regime had not been communicated effectively, and points in our view to a weakness in the ECB’s communication framework. In case of a regime switch or a sudden change in the assessment of the economic outlook, intermeeting communication can play a precious role. 

• ● Our analysis shows that ECB communication has been very effective in securing long-term predictability, whereas short-term predictability has broken down in recent months. This, however, might have partly been seen as the price to pay to enhance long-term predictability and antiinflation credibility. In other words, the June surprise might have been not just a communication dysfunction, but rather a conscious decision to shock the markets, to impress upon investors the seriousness of the ECB’s anti-inflation resolve.

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Published on  Tue, Aug 5 2008, 14:33 GMT

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