BOJ, ECB and deflation problem

The Bank of Japan and the ECB came out with their policy announcements yesterday. The crux of the both was same that the uncertainty induced by the virus remains a prime concern and the economy needs support in the form of a stimulus and low rates. The inflation or the lack of it remains a problem in both the economies. In Japan the latest CPI data for December shows a negative 1.2% reading whereas in the Eurozone the December reading has come at negative 0.3%. Now our readers would know that inflation is one topic which we cover repeatedly in our notes. In a capitalist economy where there is no central resource allocator like a socialist set up, the price signals form the basis on which the economy works. A multitude of economic agents derive their own interpretations of the prices they see and make decision to produce and consume. Hence inflation aka the rate of price changes becomes important.

Apart from inflation, the inflationary expectations also play a role in deciding their economic decisions. Let’s take the above case of Japan and Europe, if falling prices convince the consumer that in future prices are going to be much lower, then they can postpone their consumption decisions. The postponement will result in low current demand, unsold inventory for producers, forcing them to constrain production. This adds to the vicious cycle. That’s why we see the central banks trying to pep up the inflationary expectations during such times so as to ensure that the demand is not procrastinated. Though the CPI basket is not entirely constituted of goods whose consumption can be postponed. Your food, fuel and power purchases can hardly wait for another day. The above example is very valid in the case of discretionary items like white goods.

Across the developed world the quest is to bring inflation to a stable 2% level. In the US, the Fed last year decided that they will allow the inflation to overshoot even the 2% before they will pull the trigger on QE policies. A very pertinent question which our reader can ask is that what is so sacred about this 2% number, what is the historical relevance of the same. Due to the paucity of space today, we will tackle this query in later notes.

In the market roundup, Dow Jones ended mildly in red yesterday. Hang Seng and Nikkei are also trading in red currently. The Dollar Index is trading closer to the crucial level of 90. One important move is visible in Pound Sterling which is trading above 1.37, a possible reason can be the reference to an orderly Brexit in the ECB Chief’s comments yesterday. US 10-year yields are trading at 1.11% currently. Just for the context the German 10-year bond yield is trading at negative 0.5%. For Germany, any rise in the Euro will also be bad news as it is the foremost exporter nation of Eurozone.

Domestically the 10-year bond yield is trading at 5.97%. The anticipation regarding the borrowing figure for FY 22 is gaining ground. As per some reports the govt can decide to borrow close to INR 10.5 Trillion in next fiscal to fund its budget deficit. In the previous budget the same figure stood at INR 8.1 Trillion which was later altered in the wake of the Covid related spending.

We will be taking a 15 days break and return mid Feb to write again.