Global Daily – How will the ECB’s rate guidance change?

by: Nick Kounis , Georgette Boele , Arjen van Dijkhuizen

ECB View: Rate guidance to be specific on time horizon – Executive Board member Peter Praet commented on monetary policy today. The institution’s dovish Chief Economist was unmoved by the recent spike in market volatility saying he saw no consequences ‘so far’. However, he also played down the recent IG Metal pay settlement, saying that it was ‘fully in line with our baseline scenario for inflation’, something also confirmed by the hawkish Bundesbank President Jens Weidmann. That remark is important given that the ECB sees subdued wage growth and core inflation in the eurozone this year and next. Perhaps his most interesting comments were on the Governing Council’s forward guidance. He confirmed the central bank’s guidance on sequencing (that interest rates would remain on hold until ‘well past’ the end of QE) saying that ‘the sequencing is an essential part of our forward guidance that anchors interest rate expectations’. Furthermore, he said as the end date for QE gets closer, the Governing Council will need ‘to be more specific about what do you mean by ‘well past’ on interest rates’. We think the ECB will be clarify the time horizon it intends in its forward guidance on interest rates, by saying on current information interest are likely to remain on hold until a specified point in the future. In particular, the ECB could state that it expects ‘interest rates to remain at their present levels until at least mid-2019’. Our current base case is that the ECB will raise interest rates in the second half of next year, with September the month pencilled in. (Nick Kounis)

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BoE View: Inflation Report signals faster rate hikes – The BoE’s Inflation Report suggested that the central bank would raise interest rates at a pace faster than financial markets expected. Based on market pricing of a Bank Rate of 0.7% at the end of this year and 0.9% the end of next year, economic growth is seen remaining above trend and inflation above target over the coming years. Indeed, GDP growth is projected to settle at 1.7-1.8% to 2021, compared to the Bank’s view of trend growth at 1.5%. Meanwhile, inflation is seen at 2.2% two years from now and 2.1% three years from now, above the inflation target of 2%. All this suggests that the BoE needs to tighten faster in order to ensure that inflation gets back to target over the medium. We now see the BoE hiking twice this year (May and November) before hiking another two times in 2019. We previously expected the central bank to leave interest rates on hold this year, before hiking twice next year. Interest rate futures move to price in more rate hikes after the Inflation Report and are now pricing in just over three hikes over the next two years.  The pace of interest rate increases in our base case would still remain modest compared to past rate hike cycles. We think the current high inflation rate (3%) is largely driven by the weakness in sterling, while domestic inflationary pressures remain muted. In addition, uncertainty related to the UK’s eventual exit from the single market and EU could be a more significant drag on demand. Our changed BoE projection has also trigged an upgrade in our sterling view. We now see GBP/USD at 1.42 by the end of this year (previously: 1.35) and 1.52 by the end of next (1.50 before). (Nick Kounis & Georgette Boele).

China Macro: January surge in import growth biased by Lunar New Year effect – Chinese trade data are notoriously volatile. That is particularly true at the start of each calendar year. The timing of China’s Lunar New Year celebrations, which generally take a week or so, differs from one year to another. In 2017, the start of the Year of the Rooster was celebrated from 27 January until 2 February. This year, the holiday marking the start of the Year of the Dog will be held from 15-21 February. So this year, January clearly has more working days than January last year had. These different holiday timings can have a strong impact on Chinese statistics. This was illustrated for instance by Chinese import growth published this morning. In dollar terms, annual growth of import values surged to a 11-month high of 36.9% yoy in January, clearly above the 2017 average of 16%. This very strong number followed a remarkably weak December 2017 number (+4.5% yoy). In monthly terms, the January increase was much less spectacular, at 1.7% mom. Higher import prices also seem to have played a role in explaining the January figures. All in all, while the January PMIs suggest the Chinese economy entered 2018 on a solid footing lifting China’s imports, one should not put too much weight on the January trade figures and should wait for the February and March data to get a clearer picture. Our baseline scenario assumes import value growth to slow materially this year (partly reflecting base effects from last year) in line with consensus, but this slowdown should be much more moderate in volume terms – in line with our gradual slowdown scenario. (Arjen van Dijkhuizen)