Global Daily – The ECB’s trillion euro challenge

by: Nick Kounis , Aline Schuiling , Maritza Cabezas

Global-Daily-Insight-5-September-2014.pdf ()
  • ECB suggests that asset purchases and TLTROs could lead to sharp rise in balance sheet
  • German factory orders rebound, boding well for Q3 GDP
  • Trend in US private employment remains strong, while US service sector rebounds

ECB signals strong balance sheet expansion

The ECB cut its policy rates by a further 10bp and announced a new asset purchase programme, which would focus on ABS and covered bonds (please also see our ECB Watch note). The central bank will announce the details of the programme following next month’s meeting. It said that it expected the asset purchase programme together with the TLROs to lead to a ‘sizeable adjustment’ of its balance sheet. Mr Draghi expressed some uncertainty about the exact numbers, but did mention getting the balance sheet back towards 2012 levels. This implies a balance sheet expansion of 1 trillion euros from a combination of asset purchases and TLTROs.  That seems optimistic. Given that a significant proportion of the TLRTOs will be used to repay the LTROs, net lending by the ECB will likely increase by EUR 600bn even if the TLTROs end up being at the top of the ECB’s range of estimates (one trillion euros). In addition, it would be a challenge to set up an asset purchase programme of more than EUR 100 – 150bn given the size of the ABS and covered bond markets. Overall, then, the TLTROs and asset purchases will likely lead to a large balance sheet expansion, but not quite back to 2012 levels.


Actions positive for the economy

We think the measures will have positive effects on the economic outlook. The package will likely put (even) further downward pressure on the euro, which will give an impulse to economic growth and inflation. In addition, they will help to improve bank lending. The TLRTOs, and the ABS and covered bond programmes will provide banks with lower cost funding. Furthermore, these measures are part of a more comprehensive package of measures. The AQR and stress tests should increase the transparency of bank balance sheets and lead to re-capitalisation where necessary.


ECB sticks to scenario of moderate recovery, slow rise in inflation

The central bank revised down its forecasts for growth and inflation, but only modestly. So the ECB is sticking to its scenario of a moderate economic recovery, with low, but slowly rising, inflation. Given that our central scenario is broadly in line with the ECB’s, we do not expect additional measures over and above the ones announced. Though the ECB signalled it is ready to do more if risks materialise.


German factory orders rebound, boding well for Q3 GDP

After they contracted by 2.7% mom in June, German factory orders jumped by 4.6% in July. Foreign orders were particularly strong (+6.9%), particularly foreign orders for capital goods (+11%). However, domestic orders increased noticeably as well (+1.7%), with domestic capital goods orders up by 4% mom in July. All in all the rise in orders provides a positive start to Q3, which is in line with our view that GDP growth in Germany will pick up in Q3 and Q4 on the back of a weaker euro and strong domestic fundamentals.


Trend in US private employment remains strong, while US service sector rebounds

US ADP private employment rose by 204K in August down from a revised 212K the month before (initially reported 218K). The trend in job growth suggests that the labour market remains strong. Gains above 200K are sufficient to bring down the unemployment rate at a significant pace. The ADP report is generally an appetizer for today’s nonfarm payrolls. We expect an increase of 250K. Finally another report released yesterday showed that the growth of the US service sector hit its highest in more than 8 years in July. Indeed, the non-manufacturing index continued to trend up, bringing the composite index to 59.7, a level which is broadly consistent with GDP growth of around 4%. Looking further down the road, we think that the second half of the year will see continued strong momentum in US economic growth.