This morning has brought news which suggests that the claimed pivot from some ECB policymakers would be sensible.
Annual growth rate of broad monetary aggregate M3 increased to 3.6% in January 2025 from 3.4% in December (revised from 3.5%).
In fact 3.6% is the latest level overall.
averaging 3.6% in the three months up to January.
So we have a push for nominal demand in the economy of the order of 3.6% some eighteen months ahead and that is significant because it is the horizon at which at interest-rate change would fully impact. We do not know how much of this will be inflation and economic growth in terms of a breakdown. But we do know that economic growth has been weak so if we suggest 1% then we will have 2.6% of inflation. Now the numbers are not that precise but as you can see we are questioning the recent interest-rate cut.
Plus the ECB is actively suppressing money supply growth at the moment via its QT balance sheet reductions. So let us take a look at that.
QT
On the 18th of this month Piero Cippolone looked at this issue and he was in boastful mood.
The ECB’s balance sheet has been reduced at a faster pace than those of central banks in other major economies during their tightening cycles (Chart 3). So far, much of this decline can be attributed to banks’ repayments of TLTRO loans.
So he cheerleading for a reduction in something other central banks did not do. Oh Dear! But perhaps his audience were not aware.But for our purposes there is probably an implicit brake on money supply growth here but it is impossible to be precise about it. But then we got an explicit move.
Looking ahead, however, any further reduction in the size of our balance sheet will stem from the gradual unwinding of our asset purchase portfolios, as the Eurosystem no longer reinvests the principal payments from maturing securities.
Investors will be buying these bonds and paying money for them so there is a reduction in the money supply. If I go back in time the UK used overfunding for a while to reduce the money supply back when Margaret Thatcher was Prime Minister and the impact will be similar.
Anyway Piero did suggest some numbers for the impact here.
In other words, a €500 billion drop in non-borrowed reserves – similar to the one expected in 2025 as a result of the decline in our APP and PEPP holdings – is associated with a €75 billion decline in credit supply, equivalent to about 0.6 percentage points of downward pressure on loans to the non-financial private sector.
So without the impact of QT let us be conservative and say that broad money growth would be 4%. Then with growth at 1% we are looking at an inflationary push of 3%.
Inflation
This is what Piero told us.
The disinflation process is well on track, and our staff projections see inflation averaging 2.1% this year, 1.9% next year and 2.1% in 2027.
Actually it has risen for the past 4 months and we have also seen higher numbers in the UK and US. Plus on Monday I looked at the words of the Belgian central bank Governor and have now spotted this bit from one of his slides.
“Green energy – Europe’s wish – will cost EUR 70 per MWh at best. Fossil energy in the US costs 10 EUR per MWh. If Europe continues to make this choice, we will lose a large part of heavy industry.” ( @PeterdeKeyzer)
If we stay for a moment with our deindustrialisation theme then I note this from Italy earlier.
On a trend basis, in December 2024, industry turnover, adjusted for calendar effects, recorded a decline of 7.2% in value (-7.0% on the domestic market and -7.5% on the foreign market) and 7.7% in volume (-8.3% on the domestic market and -6.4% on the foreign market).
For those who want more precise detail on this.
The calendar-corrected indices of turnover in value for the main industrial groupings show, on an annual basis, a marked decline for capital goods (-9.4%), intermediate goods (-8.9%) and energy (-5.2%) and more moderate declines for consumer goods (-2.7%).
This shows that you can get deflation ( a fall in aggregate demand ) and inflation at the same time. But for our purposes today we have perhaps two types of economics in tune. What I mean by that is we have the money supply suggesting inflation and also cost push inflation via ever higher energy prices.
Meanwhile Piero assures us that this will not happen in his Ivory Tower.
Most measures of underlying inflation suggest that inflation will settle at around our 2% medium-term target on a sustained basis. In particular, the ECB’s measure of the persistent and common component of inflation (PCCI)[13] – a more forward-looking indicator of underlying inflationary pressures that tends to better predict future inflation – stood at 2.1% in December, and 2.0% when excluding energy.
How did that work out for Piero and his colleagues in 2020 and 2021 when ECB President Lagarde used it as a basis for her inflation is a “hump” prediction? For those unaware Kelis can help out.
Might trick me onceI won’t let you trick me twiceMight trick me onceI won’t let you trick me twice, no
Fiscal Policy
We have previously looked at France in this regard as ir was supposed to be cutting its budget deficit. But more recently we have seen promises of higher defence spending under pressure from this.
Donald Trump has threatened to slap 25 per cent tariffs on imports from the EU, as he lashed out at the bloc, saying it “was formed to screw the United States”. ( Financial Times)
That will have the Financial Times in a spin.After all EU trade barriers are a sign of strength according to it which they are no doubt hoping readers will forget But there is a little more detail below.
“We have made a decision and we’ll be announcing it very soon,” Trump said when questioned about his plans for EU tariffs. “It’ll be 25 per cent generally speaking, and that will be on cars and all other things.”
So the EU will be doing a U-Turn on the Stability and Growth Pact and an idea of the numbers is below.
Each additional 1% of GDP in defence spending in Europe is 170 Billion €. To get to the new target of 5% proposed by Trump it would take more than 500 B€ per year. ( @MichaelAArouet)
Now I doubt Europe will get anywhere near the 5% of GDP demanded by President Trump. But a 1% increase is feasible and then we have even more expansionary fiscal policy which with money supply growth is what fed the inflationary fires in the cost of living crisis.
Comment
As you can see the ECB is being pulled in two directions at once. One was identified by Joachim Nagel the head of the German Budesbank on Tuesday.
At present, the German economy is in a state of stubborn stagnation. Real gross domestic product has seen practically no growth since 2018…….In any case, it is not possible to rule out a third consecutive calendar year with no growth.
On the other side of the coin is the inflationary risks that are around. Money supply growth has picked up and we look set for more defence spending. In the past defence spending has proved to be rather inflationary as well as boosting aggregate demand. Under President Lagarde the ECB has dropped the ball badly on inflation once. Will it do so again?