By Hale Stewart
This week, there was no central theme or major report to highlight. Instead, I'll discuss the major releases from the developed regions along with some important speeches given by several central bankers.
EU news was positive. Industrial production, which has been moving sideways since 4Q15, gained 1.6% M/M and 1.8% Y/Y. All the components save energy increased. The Zew economic sentiment indicator rose 5.4 points to 12.3. But this number is mostly rebounding from a sharp post-Brexit drop that was the culmination of a year-and-a-half decline. In addition to the economic numbers, Vítor Constâncio, Vice-President of the ECB, gave a speech that clearly explained one of the transmission mechanisms of the ECB's QE policy:
In spite of the present headwinds, banks have resumed credit expansion since late 2014 to a present growth rate of 1.9%. This improvement is also evident from the latest bank lending surveys (BLS), which reveal a continued easing of credit supply standards on loans to firms which is largely driven by increasing competition among banks. This increased competition has been one of the main mechanisms through which our measures - notably TLTROs - have been operating and has squeezed bank margins, causing bank lending rates to fall and, consequently, net demand for borrowing to increase. As banks begin attracting additional borrowers, this leads to a gradual easing of credit standards and an additional strengthening of competitive pressures which lower lending rates and increase loan demand further. This in turn supports macroeconomic conditions and reduces non-performing loans, thereby validating ex post the lower lending rate and creating a positive feedback loop. In effect, our credit easing measures have stimulated banks to start competing again for good credit.
QE critics in several jurisdictions have cited weak bank margins as a prime reason for their objections to central bank easing. But the above paragraph provides a potent counter-argument: although margins are weaker, the positive macro-level impact of increased lending spurs economic activity that eventually lowers banks' loss reserves.
Strong housing numbers were the only Canadian news; they rose 19.7%. This was the biggest increase since 9/15. There were strong gains in urban single and multiple urban structures. In addition to the economic numbers, Bank of Canada President Poloz gave a presentation on trade and monetary policy that contained the following explanation for the decline in trade:
The weakness of global trade growth in the past few years has attracted considerable attention (Francis and Morel 2015; Poloz 2016). A key reason seems to be that globalization has happened in waves that cannot be expected to be repeated. Early development of global value chains (GVCs) was mainly the product of technological improvements and falling tariffs and other costs, such as transportation and logistical support costs. GVC development received a major boost when China joined the World Trade Organization (WTO), which, again, can only happen once (Ferrantino and Taglioni 2014; Constantinescu, Matoo and Ruta 2015). A second reason is that the world has entered a phase of subdued business investment because of the weight of post-crisis uncertainty, and investment spending is a very trade-intensive activity. Accordingly, soft investment has a disproportionate effect on global trade flows (Morel 2015). A third reason, offered by Stratford (2015), is that emerging markets generally have lower import elasticities than advanced economies; consequently, as the relative contribution of emerging economies to global GDP growth rises, the global income elasticity of trade has been declining. It is therefore reasonable to expect global trade to pick up as the world economy gathers momentum; but it seems less likely to exceed global GDP growth to the same extent as in the past.
The entire speech offers numerous insights into global trade and monetary policy.
Although there was no major economic news from Japan, BOJ board member Yutaka Harada gave a speech that explained the importance of inflation expectations for Japan:
Second, I would like to describe factors that have hampered the achievement of the 2percent target. In terms of the mechanism that I have just described, a rise in inflation expectations is crucial. However, the rate of increase in the observed inflation rate - i.e., the CPI - continued to decline due to (1) the fall in crude oil prices, (2) the weakness in demand following the consumption tax hike in April 2014, and (3) the slowdown in the global economy and volatility in global financial markets. The decline in the observed inflation rate weakened inflation expectations adaptively, and this decline then pushed down actual prices
Here, understanding the mechanism of inflation expectation formation - the third aspect - becomes important. Since the observed inflation rate is likely to remain subdued for the time being, it seems that a further rise in inflation expectations through the adaptive mechanism is uncertain and may take time. This highlights the important role played by the forward-looking expectation formation mechanism. The expansion of the monetary base, together with the commitment to achieving the price stability target, by bringing about a regime change in monetary policy, has led to a rise in inflation expectations. The relationship between the monetary base and inflation expectations seems to be of a long-run nature. Therefore, what is important is the Bank's commitment to expanding the monetary base in the long run.
Harada is arguing there are several reasons for Japan's weak CPI, starting with oil's price decline. He's also implying that oil will continue to negatively impact CPI for the foreseeable future. Next, he notes that growth has been weak since the consumption tax hike. Like oil's effect, he's also arguing that growth will continue to be weak. Hence, for Harada, the primary method of increasing inflation expectations is through forward expectations, which explains why the BOJ recently added to its easing program
The only UK news was the 1.5% M/M decline in construction spending.