Draghi gets some extra policy legroom as inflation falls back

Draghi gains some credibility as inflation pulls back

Mario Draghi will be preparing the "I told you so" part of his April governing council meeting opening statement after inflation edged back in the March preliminary numbers.

Is he totally justified? I don"t think we can tell on just one number, especially one that"s been rising for nearly a year. This time last year CPI was -0.1%, the bottom of this huge tear since then. The ECB like to trot out the oil excuse for why inflation is higher and that"s fine but oil hasn"t really dropped back at all since it"s bottom in early 2016.

The general thinking behind the energy/inflation relationship is that inflation lags by anything from 7-9 months, so if that"s true, that puts inflation somewhere about here on the oil chart.

Brent daily chart

It the relationship is correct, we should see inflation stabilise in a tight-ish range for around 6 months before moving higher again, funnily enough, right about the time we get to the near the end of the latest QE extension (at a lower rate of course). 

I"ve said for a while that Draghi is in a win win situation. If inflation does fall back dramatically, his QE extension is justified, If it carries on higher, well, QE has worked as inflation is more stable and trending higher. Draghi isn"t a central banker right now, he"s an oil trader and he"s trading ECB policy on the back of it. One big test for Draghi will be if the oil deal gets renewed with additional production cuts, and prices rise to a new base level. 

Another thing to think about is why the Eurozone CPI is lagging behind that of the US and UK, and particularly the core number. That"s more an indication of the weakness still in the EZ economy overall as it is still lacking that of both the other countries. The Eurozone is still way behind on unemployment and wages so if we start to see those improve, that"s another brick in the inflation wall.

For now, the market might believe him and the euro might suffer because of it. As I type we"re testing the lows at 1.0670 but it"s slow going. One swallow doesn"t make a summer so next months CPI data might be a real mover for the euro.

Draghi gets some extra policy legroom as inflation falls back
Draghi gets some extra policy legroom as inflation falls back
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