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Daily Agenda: The Limits of Monetary Policy

Deflation in Japan and Europe tests the limits of central bank policy while a surprise aboutface by the Bank of Russia underscores mounting political pressure on the Kremlin

Data released this morning in Japan was sobering for both the Abe administration and policymakers at the Bank of Japan. Consumer inflation levels for December, excluding food, registered at 2.5 percent year-over-year, lower than consensus forecasts. Critically, core prices calculated to exclude the impact of the sales tax increase declined sequentially to 0.5 percent above December 2013, the lowest measure in 18 months, while household spending for the month was much lower than anticipated — contracting at an annual rate of 3.4 percent. A gain in industrial production and employment suggests that activity is picking up within the island nation, but these improvements have yet to reverse the deflationary trend despite the central bank’s massive easing program. While the rapid decline in oil prices is an easy scapegoat for weak inflation, the dip in consumer spending is harder to explain. In statements today BoJ Governor Haruhiko Kuroda defended his strategy in the face of political criticism, insisting that the bank’s inflation targets will be achieved in the long term. Speculation has heated up among analysts that the central bank may expand its yen printing scheme to regain price momentum. This may be less important to investors in the long run than a bigger, more abstract question: Has the global economy reached the limits of monetary policymakers’ ability to drive growth? Even in the U.S., where activity and employment measures are robust, inflation remains subdued and wages continue to stagnate. With the week coming to a close, discussions of the success of the ongoing experiment in Japan will be a focus for markets preparing for a new round of easing in Europe.

Russia lowers interest rates. In a surprise move that suggests capitulation, the Bank of Russia today lowered the benchmark one-week auction rate from 17 percent to 15 percent, as central bank governor Elvira Nabiullina and her colleagues shifted focus from inflation and a weakening ruble to softening recessionary trends in activity. This move comes on the heels of six rate increases last year, which failed to achieve the desired effect. The perfect storm currently battering the Russian economy — which combines Western sanctions with collapsing oil prices — has left the Kremlin in a vulnerable political position at home.

Euro zone inflation softens. Core consumer price index levels for the euro area in January registered at an anemic 0.5 percent year-over-year, while the headline index contracted by 0.6 percent under the weight of collapsing energy prices. With the specter of deflation casting a shadow over the region, the ambitious quantitative easing plan of European Central Bank president Mario Draghi will now be put to the test. Separately, headline unemployment for the 19 nation group for December released today by Eurostat was marginally better at 11.4 percent but remains well above historical averages.

More U.S. economic data on tap. Today will be a busy day for economic indicators in the U.S. ,with fourth quarter personal consumption expenditures figures slated for release, as well as final University of Michigan consumer sentiment index levels for January. The biggest announcement of the day will undoubtedly be revised fourth quarter GDP numbers, with analysts forecasting a reduction from the initially reported brisk pace of growth.

Earnings season marches on. Eli Lilly & Co. was the latest major drugmaker to guide expectations lower despite beating fourth quarter estimates, as a combination of the impact of a strong U.S. dollar on international sales and expiring patents on key drugs caused it to significantly lower its anticipated revenue range for the year ahead. Weyerhaeuser reported earnings of $0.27 cents per share, falling short of consensus analyst estimates by a penny. The Federal Way, Washington–headquartered paper and timber company also posted revenue that fell short of expectations. Good news arrived for the consumer financial sector this morning as MasterCard posted better than forecasted earnings of $0.69 per diluted share, with a purchase volume that increased by 12 percent over the prior year.

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