At its December meeting, the European Central Bank extended its quantitative easing program until September this year but also announced it would scale back the monthly rate at which it purchases bonds from 80 billion euros' worth to 60 billion euros.
Since the meeting, the yield on the 10-year German bond yield has declined by about 20 basis points, to 0.19%. The euro has softened a little against the US dollar from a bit over $1.07 in the few days prior to the ECB meeting to just around $1.06 now. Also, the eurostoxx50 has advanced by about 4%.
The positive reaction to what was in effect an ECB crack at tapering its QE program stands in sharp contrast to the "taper tantrum" seen in 2013 when Ben Bernanke floated the idea of doing the same thing with the U.S. Federal Reserve's QE program. What explains the difference?
First, the way the ECB presented its policy was very dovish. In 2013, on the other hand, the market was very skittish about the Fed's intentions. Second, ECB purchases are sure to continue at the current rate until at least September, with the implication of further buying into 2018; when the Fed scaled back it did so quite quickly. Third, the ECB also allowed itself to buy bonds below the current deposit rate, minus 40 basis points, and benchmark German bonds are still in short supply. Fourth, markets see continuing low core inflation in the euro area. If the ECB's scaling back of purchases was a "stealth tightening" then it was a very stealthy one indeed. Monetary policy is still very accommodative and should support growth.
Growth itself shows encouraging signs of a pickup. The manufacturing purchasing managers' index is the strongest it has been since late 2013. The composite eurocoin indicator is back at levels last seen in 2013 and is consistent with the accelerated growth seen in gross domestic product numbers for the fourth quarter of 2016. The pickup that is evident in global manufacturing, helped by better Chinese numbers and a post-election upswing in animal spirits in the U.S., seems, together with a soft euro, to be stimulating the manufacturing sector: New export orders are leading total orders higher. This should be good news for investment and employment in the manufacturing sector, with positive spillovers to services.
Monetary and global influences are therefore currently giving favorable tailwinds for activity. However, headwinds are building. Among the purchasing managers' indexes, the most lackluster is for retail sales, which has gyrated a bit over the last year but is essentially flat. Consumer sentiment is also trendless, though it has been at solid levels for some time. Thus, consumption is not presently reinforcing the momentum that is building in manufacturing.
The reason is not difficult to find. While employment growth slowly accelerated during last year, to about a 1% year-on-year rate, real wage growth has slowed. Headline inflation was a little below zero in the spring of 2016 but, due to base effects from oil, accelerated sharply to 1.1% in December. Meanwhile, wage growth remains only a little above 1%. With headline inflation likely to rise to around 1.5% in early 2017, real wage growth should turn negative, which seems certain to slow consumption, after a while.
2017 is an important political year in Europe, with elections in the Netherlands, France and Germany as well as the possibility of an early election in Italy. Depending on how the polling goes, there is a chance that uncertainties will weigh on sentiment, and therefore on spending in the corporate and household sectors. Also, fiscal policy should be a little less stimulative than last year.
After very little progress on Brexit following the U.K.'s referendum in June, things are likely to start moving very soon: The scope for disagreements between the U.K. and EU is a threat to sentiment.
Overall, while global and monetary trends are supportive of growth, higher inflation should dampen the consumer while political risks to sentiment are clear. It is likely the market will revise up its assessment of 2017 growth in the coming months -- but with a distinct risk of a midyear slowing due to the consumer.
We should not get carried away.
Paul Mortimer-Lee is global head of market economics at BNP Paribas in New York.