Daily Commentary BY THE CURVE TEAM –

Monetary Policy Divergence To Continue

30th of May, 2017

In what was a very quiet night with the US and other key markets closed, comments from the Mario Draghi and other ECB members grabbed the headlines. While many see the tide starting to turn in Europe as the data continues to beat expectations, the ECB are in no danger of getting ahead of themselves. 

Over the last couple of weeks, in the face of improving data, ECB members have continually downplayed its impact on the outlook for monetary policy. Instead of focusing on the improving growth story, they continue to point to the enduring inflation weakness. 

ECB President Mario Draghi once again emphasised the focus on inflation overnight, saying that “for domestic price pressures to strengthen, we still need very accommodative financing conditions, which are themselves dependent on a fairly substantial amount of monetary accommodation.”

This is similar to the rhetoric we are familiar with from the FOMC, who continued to point to lacklustre inflation readings, even as the economy and especially employment outcomes continued to improve. 

One key reason for this, and one that Australians are currently acutely familiar with, is wage growth. Austrian central bank governor Ewald Nowotny, who also sits on the ECB’s governing council said overnight that “if the upswing gets more consolidated, I think we can expect higher wage dynamics, which means that also core inflation might get stronger.”

That right there is the key and where the transmission mechanism is currently broken. Even though employment growth is solid and unemployment is still falling in the US, wage growth is still largely absent.

Until we see wage growth, a sustainable pick up in core inflation globally is highly unlikely.

David Flanagan

Director - Interest Rate Markets