Axa IM fixed income head says euro collapse more inflationary than ECB printing euros
The eurozone falling apart carries more risk of localised inflation than printing money to save it, while recent precedent for quantitative easing from America and the UK does not suggest immediate links to inflationary expectations, says Axa Investment Managers’ fixed income chief investment officer.
The sentiment from Chris Iggo comes on a day a survey from Germany’s Allianz Global Investors found investors in Germany, France, Switzerland and the UK all feared inflation over the coming 12 months could threaten their investment goals.
With Austria, Italy, the Netherlands and Norway more fearful of deflation, the eurozone overall was fairly evenly split.
Axa’s Iggo said: “I don’t think there are significant inflation risks from the ECB agreeing to do quantitative easing – in fact, there are more inflation risks from a collapse of the euro, as any scenario involving countries giving up on the single currency and re-introducing national currencies would involve big shifts in relative currency values, and increased inflation in those that devalue versus the core.”
He noted evidence from the UK’s and the US’s “unconventional monetary policies” suggested “no significant impact on longer term inflationary expectations”.
The Federal Reserve’s own chosen measure of inflation expectations – the five-year forward break-even inflation rate – has recently shifted to the low end of its historical range, at around 2.3%, Iggo noted.
“Similarly, UK break-even inflation rates – 10-year – are at just 2.6%. Actually, I think these are too low, given medium-term inflation risks, and at these levels the market is providing investors with cheap inflation protection.
“However, the point is that the evidence suggests QE has not had a meaningful impact on inflationary expectations as measured by the bond markets [and] there is no reason to think that this would be any different in the euro area. Indeed, the deflationary risks are much greater as the area goes into an economic downturn.”
The break-evens on inflation linked bonds in Germany – which after the UK is the EU electorate most nervous about inflation, says Allianz – fell since early November, and now sit near historic lows.
Iggo said he had always focused on the positive side of the debt crisis “as something would eventually be done to prevent the euro breaking up.
“I doubt that I am alone in having my faith shaken in recent months. Also, I have always believed that the outcome to the crisis is somewhat binary – either the euro breaks up, and there are some horrendous implications of that happening, or Europe strives to achieve an even greater level of integration and centralisation of fiscal policy.
“The latter involves a lot of hard work, political negotiating, treaty changes and clear leadership, but would ultimately be to the benefit of Europe’s citizens.”
Iggo dismissed those arguing all this would be driven undemocratically by Brussels technocrats. “The alternative, of allowing a period of economic chaos and shift towards nationalism in the European political arena, is no guarantee of democracy, either.”
He said markets briefly sending 10-year Bund yields above those on gilts – otherwise not evident since the early 1980s – reflected “the trend toward diminished German influence over monetary policy and, at the same time, greater credit risk for the key provider of sovereign bailout funds in the euro area.
“This is clearly not because there is a belief that the ECB is going to be increasing interest rates – indeed, the overwhelming consensus is that interest rates are likely to be cut again – but because of the gradual decline in the credibility of the European policy framework.
“It is not a reflection, either, of the state of German public finances, but a general rise in credit risk in the euro area.”
By driving German yields higher, Iggo said, markets are “trying to force a shift in the policy stance of the ECB that will result in a change in the circumstances that have historically meant Germany has lower yields than many other AAA-rated countries”.
He noted “intense” opposition to the ECB printing money wholesale to buy troubled debt, not least because it would raise questions of moral hazard.
But not allowing it, he said, “raises the systemic risks in the euro area – risks that borrowing costs will continue to increase and risks that the euro could eventually fall apart”.
He said it was difficult to foresee borrowing costs for Italy, Spain or other troubled debt falling permanently “on anything other than the ECB being used as a lender of the last resort. All else, so far, has failed. How bad the pressure has to be, how many more governments are to fall, and how extreme does public resentment have to become, before we get to that stage, remains to be seen.”