Global Daily – ECB to finally shift assessment to the downside

by: Nick Kounis , Arjen van Dijkhuizen , Bill Diviney

ECB View: Governing Council slowly shifting to revising outlook – Given the disappointing economic data flow, we think the ECB will finally shift its assessment of the balance of risks to being tilted to the downside at its meeting later this week. At the December meeting, the Council already seemed to be shifting in this direction. It noted that ‘the risks surrounding the euro area growth outlook can still be assessed as broadly balanced. However, the balance of risks is moving to the downside’. Since then, the economic data flow has remained weak, and at 1.7%, the ECB’s economic growth forecast for this year looks very optimistic. We think that this would be a signal of further downgrades to the central bank’s economic growth and inflation projections in its next economic update. This will set the scene for a change in its forward guidance by the June meeting. Indeed, we expect the Governing Council to change its forward guidance on interest rates to signal that it no longer expects to raise its policy rates this year. The current guidance states that the key ECB interest rates will be maintained at ‘present levels at least through the summer of 2019, and in any case for as long as necessary to ensure the continued sustained convergence of inflation to levels that are below, but close to, 2% over the medium term’. We expect this to change to ‘present levels at least through the end of 2019, and in any case for as long as necessary…’.

We expect a 10bp hike in all the policy rates in March 2020 and a second 10bp increase in September 2020. However, we see the risks skewed towards an even longer period of unchanged interest rates given the slow growth environment and subdued underlying inflationary pressures.

Meanwhile, we also expect the ECB to hint that it is preparing to announce changes to its TLTRO programme going forward. We think that the ECB will announce an extension of its TLTRO programme. In the current context, we see this as mainly trying to ease refinancing problems for Italian and, to a much lesser extent, Spanish banks. We estimate that Italian (EUR 250bn) and Spanish (EUR 150bn) banks have taken more than half of the TLTRO funds (EUR 761 bn). At the same time the ECB will unlikely want to simply face the same ‘re-payment hump’ problem a couple of years down the line. So we expect it to change the programme in such a way to allow the banks more time to repay, while encouraging them to do so. (Nick Kounis)

China Macro: Signs of stabilisation in growth momentum – Yesterday, China’s official GDP growth rate for Q4-18 came in at 6.4% yoy, in line with market expectations, including ours. While this was the slowest rate since the global financial crisis, it shows that – at least in official growth terms – China’s economy is still on a gradual slowdown path, fitting with its transition towards a consumption-based growth model and Beijing’s attempts to reduce financial risk. Full-year annual growth dropped from 6.8% in 2017 to 6.6% in 2018, staying just above Beijing’s growth target of 6.5%. In quarterly terms, growth dropped to 1.5% qoq (Q3-18: 1.6%). That said, China’s industry showed serious signs of cooling in late 2018, reflected for instance in both manufacturing PMIs dropping below the neutral 50 mark and export and import growth turning negative Still, the latest hard data point to some early signs of stabilisation and came in generally better than expected. Industrial production growth rose back to 5.7% yoy in December (November 5.4%, consensus expectation: 5.3%). Retail sales growth edged up marginally to 8.2% yoy (November and consensus expectation: 8.1%). Fixed investment growth has rebounded over the past months supported by some fiscal stimulus gradually filtering through, but remained at 5.9% yoy in December. Bloomberg’s monthly GDP tracker – which shows more cyclical variation than official growth – bounced back to a three-month high of 6.6% yoy (November: 6.4%). Going forward, we expect more signs of stabilisation going forward (and the longer-term slowdown to remain gradual), as Beijing continues with piecemeal fiscal and monetary support measures, while the likelihood of an US-China trade deal has risen in our view. Still, in Q1 trade and some other data may prove quite volatile, given the annual shift in timing of the Lunar New Year break and possible distortions from previous frontloading of trade flows. For more background, see our monthly China report published earlier today (Arjen van Dijkhuizen)

UK Politics: How a second referendum could happen – Prime Minister Theresa May presented her ‘Plan B’ Brexit proposal yesterday afternoon, which involves consulting with her backbench MPs and the DUP, and going back to the EU in an attempt to renegotiate the controversial ‘backstop’ proposal. Having given up on cross-party solutions to the parliamentary deadlock over Brexit, her latest move is aimed at bringing the right flank of her party on board. We believe this approach will fail, for two reasons. Firstly, Ireland has flat-out rejected any renegotiation of the backstop. Secondly, even if a renegotiation on this point were somehow successful, it is unlikely the entire Conservative Party would back the deal, nor (potentially) the DUP. Given the government’s slender majority, the risk that it does not pass looks high.

However, one way of broadening the appeal of the deal to parliamentarians would be to offer a referendum on it. Conservative Remainer MP Anna Soubry suggested yesterday that she could support a version of May’s deal in parliament if it were subject to a public vote that included a Remain option. This view could well be widespread among parliamentarians, particularly the opposition, where support for a public vote is gaining traction. While the Prime Minister expressed scepticism over a referendum in her statement today, she did not rule it out either. Much will hinge on whether the Labour Party officially comes out in favour of a second referendum in the coming days, now that the chances of the alternative – a cross-party consensus for a soft Brexit – have fallen. Should Labour’s position shift, the next step would be the party voting in favour of a Referendum amendment to May’s Plan B motion on 29 January. While the vote could be a close one, this would send a strong signal to the Prime Minister on the strength of support for a referendum. (Bill Diviney)