We have made some changes to our forecasts for the eurozone economic outlook, ECB view and rates. The changes stem from the recent and ongoing weakness in eurozone and global economic data that suggest the period of weaker economic growth will be more protracted. We have lowered our GDP growth forecast for 2019 to 0.8% from 1.1% previously, taking us further below consensus forecast (1.4% according to the Bloomberg survey). Indeed, our projection is for a growth rate less than half of the ECB’s current forecast. Given weaker prospects for the economic outlook, we expect the ECB to keep interest rates on hold until December 2020 (first hike was previously March 2020). An ongoing re-pricing of ECB and macro expectations should see bund yields fall further to around zero over the next few months, with curves flattening further. Below we will explain the changes in more detail.
Euro Macro: Sub-trend eurozone growth to persist in the first half – The momentum in the economy continued to weaken at the start of this year and there is no sign yet of a turn in forward-looking indicators. The weakness in global trade and production looks set to persist as the tightening of global financial conditions that we saw last year will continue to feed through. The weakness in eurozone exports is also leading to a slowdown in fixed investment growth. The economy will probably see sub-trend growth rates in the first half of this year, before a return to trend rates in the second half of the year. This is based on the relative resilience of domestic demand combined with an improvement in the global economy. Domestic demand should be underpinned by easy financial conditions, lower headline inflation and some fiscal stimulus. The improvement in global growth should be supported by the dovish shift by global central banks, which is arresting the tightening of financial conditions. However, central banks have are far from stepping on the gas, so we do not expect a sharp recovery in global growth (see also our Macro Weekly – Are policymakers doing enough?).
ECB View: Longer period of low rates, fresh (T)LTRO likely – We now expect the ECB to remain on hold until the very end of next year (we are pencilling in a 10bp hike in December 2020). We previously expected a 10bp increase in March 2020 and one in September of next year. We also expect the ECB to announce a new (T)LTRO (previously an extension of the current one). At the June Governing Council meeting, we expect the ECB to change its forward guidance to rule out rate hikes for this year as well as announcing another (T)LTRO. The downward revision to our economic growth forecast means that we will see four consecutive quarters of economic growth comfortably below trend. The consequence is that underlying inflationary pressures will build even more slowly.
Euro Rates: Bund yields heading to zero – Our new forecasts imply further macro downgrades and an additional re-pricing of ECB expectations. This should lead to a further decline core bond yields from current levels. We think the decline will be concentrated in 5y and 10y yields. For instance, we now see 10y Bund yields at 0% in Q1 and Q2 (previously 0.15%). Given that the short-end will be more stable, we see the 2s5s and 2s10s segment of core government bond yield curves flattening over the next 3-6 months. This will be followed by a more moderate recovery in the second half of the year as economic growth regains some traction. We see 10y Bund yields at 0.2% by year end (previously: 0.5%). We are reviewing our country spread forecasts given the above changes, and we will publish the new projections in our Global Daily Insight of tomorrow. Finally, given weaker macroeconomic data and the longer period of unchanged ECB policy rates we have lowered our EUR/USD forecast (to 1.16 end of this year from 1.25). (Nick Kounis)