Global Daily – The ECB and trade wars

by: Nick Kounis , Bill Diviney

ECB View: Draghi signals concerns that trade wars could hit confidence – ECB President Mario Draghi signalled that the central bank currently sees the main risk from US-China trade tensions for the eurozone economy coming from the potential hit to confidence. In an event for students earlier today he noted that ‘the effect of the tariffs that have been imposed or announced to be imposed, the specific direct effects are not big… there is another more subtle channel through which these tariffs or trade exchanges can affect the economy. And I’d say we have to be especially mindful of this channel, which is the confidence channel.’ He noted that a hit to confidence could be ‘very important in the coming months’ as it could mean that companies delay capital spending plans. Last week, Executive Board member Benoit Cœuré sketched out a scenario where the US imposed a 10% tariff on all its imports and all of its trading partners imposed the equivalent on US exports (see here). According to the ECB’s estimates this would mean world trade would be 3% lower than otherwise after a year and world GDP 1% lower. However, in the current situation, the threat of tariffs involves only the US and China rather than the US and the whole world, and only a subset of goods. This may explain why Mr. Draghi emphasises the confidence impact rather than the direct effects, which would be small for the Eurozone. As such, the ECB is likely to watch confidence indicators very closely in coming months. We believe the recent softening in confidence indicators is more of a normalisation from the extremely high levels they had reached at the turn of the year. This also seems to be the ECB’s current view. However, a further softening in confidence indicators could raise concerns in the Governing Council that trade wars are having a real impact. In any case, the ECB seems to be less worried about any potential upward effects on inflation from trade wars and is focusing on potential downside risks to growth. Hence, escalating trade tensions and/or evidence of a confidence hit to the eurozone economy would make the ECB more dovish, in our view. (Nick Kounis)

US Macro: Moderate inflation supports, rather than drives, case for Fed hikes – Core CPI inflation rose 0.2% mom in March, in line with consensus, and slightly stronger than our forecast (0.1%). Inflation has picked up in recent months, with momentum as seen in the 3m/3m annualised rate now at 3.0%, a significant recovery from the lows of 0.8% in mid-2017. The pickup in inflation will give the Fed greater confidence to continue with its gradual quarterly pace of rate hikes. However, the rise in inflation has mostly been driven by core goods – for instance apparel – which is determined by global, rather than domestic factors. In March, there was some payback for apparel, which fell -0.6% mom, following unusually large gains of +1.7% and 1.5% in January and February. This was offset by renewed strength in shelter inflation, which rose 0.4%, the quickest pace since last August. However, we continue to see little sign of the tight labour market exerting upward pressure on core services inflation. With investment shifting up to a higher gear, meanwhile, we expect stronger productivity growth to dampen the pass-through of higher wage growth to inflation. As such, although the Fed will draw comfort from the recovery in inflation, we believe the hawkish shift on the FOMC is mostly due to the upside risks to growth on the back of tax cuts and fiscal stimulus, rather than fears of an imminent surge in inflation. We recently revised our Fed call, and now expect three more hikes this year at each press conference meeting, while futures markets continue to price in just two further hikes. (Bill Diviney)