The low inflation environment is here to stay

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The primary objective of the European Central Bank’s monetary policy is to maintain price stability. The ECB aims at inflation rates of below, but close to, 2% over the medium term. It’s an ambitious goal in today’s highly disinflationary environment. The era of strong growth in emerging countries is indeed over, as the consequences of imbalances in their economies become apparent. Excessive investment in recent years in Asia has led to manufacturing over-capacity and falling producer prices. The Chinese producer price index (PPI) – see exhibit 1 below – has been on a downward path for the last three years. This excess production capacity will be used to export even cheaper goods, a trend reinforced by local currencies that are depreciating.

Raw material exporting countries are being affected by the devaluation of their currencies and are consequently reducing their imports from Europe. There is likely to be a sustained fall in oil prices because supply is plethoric, with the US oil shale revolution helping it to increase its output to the point of being the world’s largest producer, and Iran returning to the global market following the long-term deal on its nuclear programme. Even if demand for oil were to rise, the supply side should be able to respond rapidly by employing new flexible extraction techniques.

In this context, how is the inflation target of close to 2% to be met? We have at least one certainty: the ultra-loose monetary policy of the ECB will also be sustained!

Exhibit 1: Year-on-year changes in China’s producer price index (PPI) for the period from 30/09/09 through July 2015. Data released by China’s National Bureau of Statistics showed that the Chinese PPI fell in July 2015 to its lowest level since 2009. The PPI index fell 5.4 % in July, according to the National Bureau of Statistics. This drop extends declines to 41 straight months and indicates weak demand both at home and abroad for China’s industrial sector.

P.Barbegraph

Source: Bloomberg, as of August 2015

©Option Finance – 7 September 2015

Patrick Barbe

CIO Core Fixed Income, Sovereign & Aggregate management team, Portfolio Manager

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