Global Daily – Euro growth to spur ECB

by: Nick Kounis

Euro Macro: Economy growing twice trend rate – The eurozone economy grew by 0.6% qoq in Q2, up from a revised 0.5% qoq in Q1 (from 0.6% previously). This left the eurozone economy growing at a rate of 2.1% over the last year, which is around twice the pace of its trend rate. The strong growth momentum – which we think is relatively broad-based – should increase the ECB’s confidence that inflationary pressures will eventually build over the medium term. So even though core inflation is likely to remain subdued over the next few months, the ECB can use the strong growth momentum to build a case for a slow tapering of asset purchases. This would be consistent with the ECB’s normal reaction function, where current growth data matter more than current inflation numbers in terms of the direction of monetary policy. Moving back to this reaction function is also practically convenient. Given the ECB’s desire to stick to the issue(r) limit in its QE programme, it would not have sufficient room to extend QE at the same pace. It could only do that if it focuses purchases on just a handful of countries’ bond markets that are below the limit, which we think it would find politically difficult to justify. Looking forward, we expect the eurozone economy to continue to grow above its trend rate, but the pace is likely to slow. Somewhat less global momentum and the stronger euro could dampen growth. Core inflation will probably not see a noticeable upward trend until next year. (Nick Kounis)

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UK Macro: BoE set to remain on hold – We expect the BoE to leave its key policy interest rate on hold on Thursday. Only two economists out of the 54 surveyed by Bloomberg expect a move at this week’s meeting. Though somewhat more expect a move before year end, the consensus is still for no change, despite BoE Governor Carney’s recent more hawkish tone. We agree with this consensus. Although inflation is above the BoE’s target, there are three reasons for caution. Economic growth has slowed, and was running at below-trend rates in Q1 and Q2. Second, economic growth is likely to remain subdued. Uncertainty surrounding Brexit could continue to dampen investment. Indeed, economic growth has been very dependent on consumer spending. Consumers are suffering a squeeze on their living standards and have compensated for that by taking the saving ratio to historically low levels, but that is unlikely to be sustained. Finally, the rise in inflation has almost totally been driven by the fall in sterling. Exchange-rate driven inflation does not tend to be permanent unless it feeds through to the economy as a whole. With wage growth still modest, high inflation is likely to be relatively transient. (Nick Kounis)