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Nadeem Walayat Financial Markets Analysiis and Trend Forecasts

ECB Meets To Tackle Deflation While Ignoring Shrinkflation

Interest-Rates / ECB Interest Rates Sep 04, 2014 - 03:39 PM GMT

By: GoldCore

Interest-Rates

ECB Meets in Frankfurt

As the Governing Council of the European Central Bank (ECB) convenes today in Frankfurt for its monthly policy meeting, markets are focusing on how the ECB will signal the initiation of its quantitative easing (QE) programme which is aimed at countering deflationary forces in the Eurozone.


In August, the annual inflation rate in the Eurozone hit a precariously low rate of 0.3% per annum. This is far below the ECB’s target rate of 2% and also far below the average rate of inflation in the Euro area over the period 1991-2014, which was 2.18%.

Financial markets are already pricing in an ECB round of QE after ECB president Mario Draghi signalled such a move last month at the Jackson Hole central banker conference in the US, where he stated that the ECB would use ‘all available instruments’ to counter deflation.

European sovereign bond yields have fallen since Draghi’s August comments and the Euro has weakened against the US dollar. It is assumed that European QE would be in the form of a bond buying programme, much like the US and UK versions of QE that have already been implemented.

The ECB is already providing cheap liquidity to commercial banks in Europe though long-term refinancing operations, and since this is not providing the necessary stimulus to boost the Eurozone inflation rate, markets will be hanging on every word of Draghi’s speech today in Frankfurt so as to attempt to predict the exact timing of the commencement of the ECB’s quantitative easing programme.

While there is plenty of evidence that governments aim to minimise headline inflation figures for political reasons, financial markets still tend to fixate on these headline figures. Financial markets also get very concerned about deflation.

Deflation causes sovereign and corporate debt repayment costs to rise, and also causes economic contraction and unemployment since consumers delay purchases expecting prices to be cheaper in the future. It is these lowly inflationary expectations (deflationary expectations) that Draghi and the ECB are worried about.

An ECB QE programme is not surprising given that the ECB’s official mandate is price stability, not just on the upside of prices but also on the downside. While many will be cynical to the fact that there is no price stability, and that the inflation rate can’t be this low, the ECB’s figures, however derived, point to this trend.

In the Eurozone, the inflation rate is calculated using a weighted average of a consumer price index where food, alcohol and tobacco count for 19%, services 41%, energy 11%, non-energy industrial goods 29%. Strip out the components of food, alcohol, tobacco and also energy, and you get something called the core inflation rate which is currently running at 0.9% for the Eurozone, up from 0.8% in July.

Shrinkflation Becoming More Obvious
This core rate of inflation however does not provide much solace to consumers who, on a daily basis, are experiencing what has become known as stealth inflation or ‘shrinkflation’.

In a recently published book, Dr. Philippa Malmgren re-highlights this ‘shrinkflation’ trend. Malmgrem is a former financial market advisor to the White House, and a former member of the US Working Group on Financial Markets, which is more commonly known as the Plunge Protection Team.

According to Malmgren, ‘Shrinkflation’ refers to the concept where companies reduce the weight or size of an item without increasing its price. In this way a company can increase its operating margin and profitability by cutting costs while maintaining the same sales volume.

Consumer goods examples include chocolate bars that are smaller, smaller breakfast cereal boxes and slimmer canned goods such as tuna. It also happens in the services industry such as hidden charges in airline travel and hotel accommodation costs.

Consumers are known to react more to price changes than product changes, hence as a first step to maintaining profitability during an economic downturn, companies try to make changes that they think consumers won’t notice. This trend is cyclical and has happened in all major economic downturns such as the late 1980s and mid 1970s.

Corporates will use various misleading strategies to deflect attention away from the shrinkage. These include less is more, less is healthier, the packaging is smaller because it is greener for the environment, or sometimes, the packaging is an innovative breakthrough in packaging design.

Other corporate spins include, the packaging costs more due to higher oil prices, and since oil is used to make our packaging, our packets have to be smaller. Interestingly, companies do not do this with clothes or electrical goods, only because they can’t obviously shrink them.

Consumer watch groups such as Which? And Consumerist have been wise to this camouflaged inflation trend for some years now, but it’s becoming so prevalent that it is now hard for the average consumer not to notice.

Companies cut costs until even the average consumer begins to notice, after which the company is forced to raise end user prices. And this stealth inflation that is currently occurring in the background will surface in the near future in the form of higher high street / main street prices.

As ‘shrinkflation’ becomes no longer viable, it will soon reveal itself in the form of higher consumer prices. And with central banks around the world creating inflation as a policy measure so as to inflate away the world’s massive debt pile, the question remains as to whether the central banks will be able to control this deliberately induced inflation in an environment where ‘shrinkflation’ no longer works.

The coming inflationary shock is unpredictable, but once ‘shrinkflation’ turns to open price inflation, then it may be too late to insulate financial assets and portfolios. Gold has always acted as a hedge against inflation. That is one of its main properties. That is also why gold should be part of a prudent investment portfolio in the coming high inflationary environment.

MARKET UPDATE
Today’s AM fix was USD 1,271.00, EUR 966.69 and GBP 772.36 per ounce.
Yesterday’s AM fix was USD 1,268.50, EUR 965.67 and GBP 769.39 per ounce.

Gold climbed $4.80 or 0.38% to $1,270.00 per ounce and silver rose $0.06 or 0.31% to $19.22 per ounce yesterday.

Overnight in Asian trading gold recovered and traded back up to close at $1,270.10 in Singapore. Further gains were seen in London where prices rose to $1272/oz before consolidating. Silver traded at the top end of the $19.10 - $19.20 range, before breaching $19.20. Platinum edged up to $1412, from $1408 yesterday but touched $1,420 earlier today.

Palladium reached $884, and was up 1.15% from yesterday’s $874. Palladium has seen some profit taking but is still in an uptrend since the beginning of the year. The recent supply deficit induced strength in palladium, and its new multi-year high earlier this week are creating additional interest from momentum traders and precious metals investors.

This update can be found on the GoldCore blog here.

Yours sincerely,
Mark O'Byrne
Exective Director

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