Global Daily – What does euro strength mean for the ECB?

by: Nick Kounis , Aline Schuiling , Fouad Mehadi , Kim Liu

ECB View: Euro strength adds to case for slow taper and rate hike delay – The euro has risen over recent days. This constitutes a tightening of financial conditions, raising the question of what it means for the ECB’s monetary policy. The euro is significantly higher than in the technical assumption in the central bank’s staff macroeconomic projections. In trade-weighted terms, the euro exchange rate is now around 4% higher. We estimate this would reduce inflation by around 0.1-0.2% in 2018-2019. This may not sound like much, but the ECB already expects inflation to undershoot over this period (headline HICP is seen at 1.3% in 2018 and 1.6% in 2019). Given ongoing weak wage inflation, euro strength adds to the case for a slower, more extended tapering of asset purchases. However, we would still expect the central bank to slow the pace of its QE programme from early 2018 onwards. This is because the programme is reaching its limits and an extension at the current pace is not practically possible, even if the inflation outlook justifies such a move. One the other hand, the ECB has every freedom to delay rate hikes. Our base scenario sees the ECB ending QE by the middle of next year and hiking in the second half of 2018. The risks are certainly skewed towards a more drawn out taper, with rate hikes being delayed at least until 2019. (Nick Kounis)

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Euro Macro: German inflation again distorted by holiday season – Inflation in Germany unexpectedly rose in June. The harmonized HICP inflation rate increased to 1.5%, up from 1.4% in May. The consensus forecast was for a decline to 1.3%. The detailed regional data showed that the timing of the holiday season – again – distorted the data. The price of package holidays rose by almost 15% mom in June, whereas last year, this summer-holiday related jump occurred in July. This means that the yoy inflation rate is likely to drop lower again in July. The regional German data also revealed that, as expected, energy price inflation declined in June. Moreover, preliminary inflation data for Italy, Spain and Belgium confirmed that a sharp drop in energy price inflation reduced the overall inflation rate in June. In Italy and Spain HICP inflation dropped by 0.4 percentage points in June (to 1.2% and 1.6%, respectively), while in Belgium inflation according to the national definition fell by 0.3 percentage points to 1.6%. The data from the individual countries that were published so far suggest that the eurozone headline inflation rate (to be published on Friday 30 June) probably declined from 1.4% to 1.2%, while the core rate stabilised at 0.9%, although the risks to core inflation seem to be tilted to the upside. (Aline Schuiling)

Euro Rates: Money market reforms a big deal for rates? – In Q2 2018, the new EU money market fund regulation will come in to force, with an 18-month implementation period starting soon. In the US,  interbank benchmark rates jumped following money market reforms. We think  the impact in Europe will be less significant. An important feature is that under the new regulations the current maturity restrictions remain the same. The reforms will lead to the emergence of new MMF types, which are expected to change the investment behaviour of MMF investors. This could lead to a slight reallocation of capital between the different MMF types as corporates and financial institutions would still need a better alternative than a bank deposit. Therefore a proportion of Euro bank paper in prime MMFs – which are subject to a conversion to mark-to-market valuations – would need to find its way to MMFs that are permitted to use amortized cost accounting (i.e. a constant net asset value). On the other hand, as corporate treasuries and institutional investors don’t have many options to park their excess liquidity, the expected capital flow away from bank paper into EGBs will be muted. We therefore calculate that a maximum of EUR 50bn invested in prime MMFs would be subject to this reallocation into short-term EGBs. We also expect corporate and institutional investors to ‘tip-toe’ the use of the new MMF types which will use the mark-to-market valuations. All in all, in contrast to the US MMF reforms, we don’t expect a sharp tightening of unsecured interbank lending conditions and therefore no significant impact on Euribor futures. Please see for more information our publication – EU money market reforms a big deal for rates? – for professional clients, see disclaimer in the document. (Fouad Mehadi & Kim Liu)