Big Picture: Last week’s news that the US economy contracted more than expected in the first quarter brought another set of challenges to our moderately optimistic outlook. However, we stick to our view that the global recovery is on track and will remain on track. This week promises to be hugely interesting, as the ECB will announce measures to prevent deflation and remedy problems in the credit mechanism. It is also going to be interesting to see how financial markets will react.
Rates: We expect the ECB to introduce a package of small measures this week, including policy rate cuts, an ABS purchase programme and an extension of full allotment to 2016. Large scale QE at this meeting looks unlikely, and it is not part of our base scenario going forward. ECB President Draghi will probably continue to sound worried about the risks of a negative spiral between low inflation, falling inflation expectations and credit. In addition, we think that headline inflation will fall a bit further. All this suggests long rates will remain low over the next few months.
FX: It was a quiet week on currency markets, but this might be the calm before the storm. The ECB meeting, global PMI data, and the US jobs report on Friday, will provide more direction to currency markets this week. We expect the US dollar to have the upper hand on stronger US data and a dovish ECB. EUR/USD is on its way to reach our target for the end of June of 1.35. Emerging market currencies came under some pressure, as investors took a more cautious stance.