Global Daily – ECB pouring cold water on rate hike expectations

by: Nick Kounis , Bill Diviney

ECB view: Communication on euro strength looks co-ordinated – The ECB now looks to be conducting a co-ordinated communication campaign against euro strength, which has been driven by building expectations of early rate hikes. ECB Vice President Vitor Constancio gave an interview with La Repubblica, which was clearly designed as a verbal intervention against euro strength. He said that ‘as it is known, we don’t target the exchange rate. But I am concerned about sudden movements which don’t reflect changes in fundamentals’. He went on to add that ‘looking at fundamentals, inflation declined slightly in December’. Mr Constancio is one of the most dovish members of the Governing Council. However, even the moderately hawkish Austrian central bank governor, Ewald Nowotny, added to the chorus. He told reporters in Vienna that ‘the main reason for the recovery has been export driven and in that context of course also the exchange rate is something that has to be observed’. He added that the recent euro appreciation ‘is not helping’. The comments from the two officials follow a verbal intervention from the Governor of the Banque de France Francois Villeroy earlier in the week who warned about the downward impact euro strength may have on inflation. Even the super hawkish Bundesbank Jens Weidmann, recently suggested a rate hike is not likely before the middle of 2019. The comments over the last few days have not had a major impact on market expectations for ECB interest rate hikes or consequently the euro, which has remained relatively elevated. The stage is therefore set for ECB President Mario Draghi at next week’s press conference following the Governing Council meeting. He has the opportunity to more forcefully push back market rate hike expectations. Markets are currently pricing in almost 8bp of rate hikes by the end of this year, and 15bp by March 2019. We continue to expect markets to scale back rate hike expectations, which should push German 5y government bond yields as well as the euro lower. (Nick Kounis)

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US Macro: Home builder sentiment remains strong – but what does this mean for inflation? The NAHB housing market index came in at 72 in January, cooling a touch from December’s 74, but still near the highest the index has been since 1999. The index gauges single family home sales expectations for the coming six months, and suggests that the rate of home ownership, which remains well below pre-crisis levels, will continue to increase into 2018. While respondents pointed to cost pressures from building materials and labour – which suggests strengthening inflation – we note an offsetting trend coming from the rise in the rental vacancy rate. As home ownership declined following the subprime crisis, the vacancy rate for housing rentals also declined, and this put upward pressure on rents. Indeed, shelter costs have been a key support for otherwise subdued inflation in recent years, with the category making up 43% of the core CPI basket, and 18% of the Fed’s target, core PCE. However, rental vacancies look to have bottomed in Q2 16 at 6.7%, since recovering to 7.5% as of Q3 17. This appears to be having an impact on the growth in shelter costs – with a lag – which have cooled in recent months, from a recent high of 3.6% y/y in Dec 16 to 3.2% in Dec 17. Higher rates of homebuilding and a continued recovery in the home ownership rate this year could mean further increases in rental vacancies, and a dampening impact on shelter costs. (Bill Diviney)