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â Higher nominal yields may require faster ECB asset purchases: Financial markets are pricing in a stronger economic recovery and a rebound in inflation. As a result, the rise in bond yields of major advanced economies has accelerated in the first two months of 2021. Higher inflation expectations account for almost two-thirds of the increase in German 10-year nominal yields from -0.6% at the end of 2020 to -0.25% now. Central banks will likely 1) welcome a moderate rise in nominal and real bond yields as a return to normal but 2) intervene if financing conditions tighten by so much so fast that they may jeopardise the economic rebound. In the Eurozone, the ECB may increase its pace of asset purchases under its flexible Pandemic Emergency Purchase Programme (PEPP). Despite a 2021 hump in inflation, we expect underlying price pressures to remain below 2% over the medium term. The ECB can thus maintain its supportive stance for years to come.
â 2021 inflation hump follows 2020 collapse: Eurozone inflation fell from 1.3% yoy in early 2020 to -0.3% in August and stayed there for the rest of the year in the wake of the COVID-19 mega-recession. The temporary cut in the German VAT and the appreciation of the euro reduced inflation in H2 2020. In 2021, the situation is changing notably. In January, headline inflation shot up by 1.2ppt to 0.9% yoy. Expect more of the same near-term.
â Temporary factors to boost inflation further: By May this year, Eurozone inflation could surge above 2% yoy and remain there until late 2021. Powerful base effects (oil price and German VAT) and special factors (broader German emissions pricing scheme) make up roughly two-thirds of the 2ppt+ rise in headline inflation. Although transport costs may remain high for a while, they are unlikely to rise much further on a sustained basis. Some bottlenecks may ease over time. The reopening of consumer services will likely result in a one-off rise in prices but not in a sustained longer-term inflationary process. The chart presents our estimates for the key drivers of Eurozone inflation, including a change in the seasonal sales pattern for clothing and footwear caused by lockdowns and the impact of a less undervalued euro.
â But this does not mean a sustained, excessive rise in inflation⦠We expect the ECB to look through the 2021 rise in inflation. The 2021 hump in inflation is a correction after the fall in prices in H2 2020. When the base effects move out of the annual comparison of prices, headline inflation could fall back to c1.3% in spring 2022, in line with its early 2020 level. Throughout 2022, we expect inflation to pick up gradually on the back of an ongoing solid economic recovery.
â ⦠in the Eurozone even less so than in the US: The extent to which underlying inflation can rise ultimately depends on the strength of aggregate demand. We expect nominal spending to rebound strongly due to ample fiscal support and pent-up demand from households who have accumulated excess savings. The US looks set to be ahead of the Eurozone. The Eurozone entered the pandemic with a bigger output gap than the US, Eurozone GDP dropped by more in 2020 and the fiscal response is smaller than in the US. We expect Eurozone GDP – and underlying inflation – to return to their pre-pandemic levels one year after the US. As even the US Fed will probably not taper its asset purchases in 2021 and may not hike interest rates before 2023, the ECB can afford to wait even longer. Although the ECB will eventually have to scale back its stimulus and want to do so, it may well raise its pace of asset purchases temporarily to manage financing costs.
Chief Economist
+44 20 3207 7889
holger.schmieding@berenberg.com
Senior Economist
+44 20 3465 2672
kallum.pickering@berenberg.com
Senior European Economist
+4420 3207 7859
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