Global Daily – ECB & Fed shifting on turmoil

by: Nick Kounis , Maritza Cabezas

Global-Daily-Insight-27-August-2015.pdf (213 KB)
  • Officials from ECB and Fed point to shifting stance following market turmoil
  • ECB Chief Economist Praet opens the door to a more QE as soon as September
  • NY Fed President Dudley strikes cautious tone on September rate hike

ECB’s Praet says downside risks to inflation have increased…

The ECB’s Chief Economist Peter Praet opened the door for the central bank to further step up its monetary stimulus as soon as next month’s meeting. In a speech at the European Economic Association in Mannheim, Germany, he struck a dovish tone. Mr Praet asserted that ‘recent developments in the world economy and in commodity markets have increased the downside risk of achieving the sustainable inflation path towards 2 percent.’ The Governing Council would discuss new forecasts at next week’s meeting and was prepared to act if necessary, with the current QE programme providing sufficient flexibility ‘in terms of size, composition and length of the program’.  He also asserted that ‘there should be no ambiguity on the willingness and ability of the Governing Council to act if needed’.

…increasing chances of more QE

Mr Praet’s remarks significantly increase the chances that the ECB will step up or extend QE as soon as next month’s meeting. However, the water is being muddied by some mixed commentary. For instance, yesterday, ECB Vice President Constancio seemed to play down the decline in market measures of inflation expectations. He said the fall in inflation expectations was down to the decline in oil prices, and that the ECB should not try to correct for commodity prices. He also seemed to play down the disinflationary impact of the Chinese devaluation. At this stage, we put some more weight on Praet’s remarks given his role at the ECB and we therefore conclude that the odds on more QE have shortened. It will be interesting to see if Mr Constancio adopts a more dovish tone in his Jackson Hole Speech later this week.

Our base case is no change for now

Our current base case is for no change in the QE programme. China risks, the drop in commodity prices and tighter financial conditions do point in the direction of more QE. However, core inflation has bottomed out and eurozone economic data have been pretty resilient.

ECB options to expand stimulus

The ECB has two options to expand stimulus. It could communicate that QE will be completely open-ended, dropping the reference to September 2016. Alternatively it could increase the size of the monthly purchases, which could also involve adding more securities to the list of eligible assets.

Fed’s Dudley cautious on rate hike…

Meanwhile, New York Fed President Dudley, the first FOMC member to speak after Black Monday, struck a cautious tone. He noted that the arguments for raising interest rates next month are less compelling than they were a few weeks ago, but he also added that “..we really hope that we can raise interest rates this year”. Most data suggest that the US economy remains solid (see also below). However, given the recent market turmoil, investor risk sentiment remains fragile. So although our base case is for a September rate hike, the risk has increased significantly that the Fed delays further .

…more signs expected from Jackson Hole

Later this week central bankers will gather at Jackson Hole to discuss “Inflation Dynamics and Monetary Policy”. On Saturday (18:25 CET), Fed’s Vice Chair Stanley Fischer will discuss the US economy. Mark Carney and ECB Vice President Constancio will also give presentations that day.

US durable goods orders beat expectations

Meanwhile, economic data continue to improve. Durable goods orders rose 2% mom in July up from 4.1%. Core orders were stronger than expected  and there were upward revisions to previous months. Durable goods orders ex-transportation rose 0.6% mom from 1% and core capital goods orders rose 2.2% up from 1.4%. This increase was the highest in a year. This adds to evidence that the US is growing at above-trend rates.