- We now expect the ECB to cut its refi rate in December, as well as stepping up forward guidance
- Our eurozone government bond yield forecasts have been revised down
- Meanwhile, manufacturing surveys suggest the global economic recovery is continuing
Change of ECB view
We now expect the ECB to cut the refi rate by 25bp to 0.25% at the December Governing Council meeting, compared to our previous forecast that the refi rate would remain on hold through next year. At the same time, we stick to the view that the central bank will also strengthen its forward guidance at that meeting. The forecast change reflects the sharper than expected decline of inflation and the increasing risk that it will get stuck at uncomfortably low levels going forward. In addition, the evaporating liquidity surplus also means that there is a higher chance that EONIA rates will be pushed up towards the refi rate, which would be an unwelcome defacto tightening of financial conditions. Finally, the strength of the euro, and recent data confirming that unemployment remains on a clear upward trend, signal that significantly disinflationary forces remain in place. We expect headline inflation to fall further in the coming months, which would leave the single currency area vulnerable to a deflationary episode in the case of a negative demand shock. A November move is possible but not probable, given that there is still resistance by officials from some of the northern member states. They and the rest of the council will probably want to wait for the updated inflation projections in December, which will also extend to 2015 for the first time. However, given that they will likely show inflation clearly undershooting the central bank’s price stability goal, it seems likely that the central bank will take action at the December meeting.
Downward revision to euro bond yield forecasts
Given our scenario for the ECB and inflation, we have revised down our German government bond yield forecasts. There has of course already been some pricing in of an easier monetary stance by the central bank, however we do not think that this process is over yet. In particular, euribor futures rate still have an upward profile for this year and next, which we judge will be further compressed by building expectations of a refi rate cut, a low ECB inflation projection and stronger forward guidance. This compression will disproportionately impact 5-Y yields, while the global economic recovery story (see below) and revival of tapering expectations will have an offsetting effect on 10-Y yields. Overall, we see the 10-Y Bund yield flat around the 1.7% mark at year-end, compared to 1.9% previously.
Manufacturing surveys paint positive picture
Meanwhile, manufacturing surveys were generally up around the world. The ISM manufacturing index unexpectedly edged up to 56.4 in October, from 56.2 the month before. The outcome, which beat the consensus forecast of a small drop to 55, marked the fifth monthly gain in a row and brought the index to the highest level since April 2011. The small gain in the headline index was mostly driven by the more forward looking new orders index (from 60.5 to 60.6), which suggests that manufacturing activity will accelerate further in coming months. All in all, Friday’s report was encouraging, in particular in the face of the deterioration of other confidence indicators due to the government shutdown, and is in line with our view that we will see a modest acceleration in growth in the final quarter of the year. The improvement in the ISM index in the US was mirrored by rises in the manufacturing PMI survey in many major economies around the world, including the eurozone, China, Japan, Russia and Brazil. It also showed gains in a number of important trading countries that are often used to monitor turns in the global cycle. For instance, the PMI rose in South Korea, Taiwan and Hong Kong. All this suggests to us that the global economy remains on track for an acceleration in growth rates in the next few months.