Global Daily – Sluggish eurozone growth makes case for ECB stimulus

by: Aline Schuiling , Nick Kounis

Euro Macro: PMIs signal ongoing weakness in growth – The eurozone PMIs for April indicate that economic growth remained subdued at the start of the second quarter. The manufacturing PMI rose slightly (up to 47.8 in April from 47.5 in March), whereas the services PMI declined from 53.3 to 52.5. As a result, the composite PMI, which gauges activity in the overall economy, fell from 51.6 in March to 51.3 in April. At its current level it is consistent with GDP growing modestly, at the pace of around 0.1-0.2% qoq, which is roughly equal to growth in 2018H2 and around half the trend growth rate. The forward-looking components of the survey such as the new orders component of the manufacturing PMI and the new business component of the services PMI, did not signal a significant change in activity in the coming months. Therefore, the PMI report seems consistent with our base case scenario that growth will remain well below the trend in the first half of this year with only a modest improvement in the second half. The slowdown in economic growth since the start of 2018 has also left its marks on the labour market. The employment component of the composite PMI has been moving lower since September 2018 and (at 52.9 in April 2019) is consistent with modest employment growth and a roughly stable unemployment rate. This means ongoing slack in the labour market, which will keep underlying inflationary pressures subdued. (Aline Schuiling)

ECB View: More to come – We expect the ECB to further push out its forward guidance on the period of unchanged policy rates and ongoing reinvestments. As noted above, the modest trajectory for economic growth will not be sufficient for underlying inflationary pressures to build. We think that ECB forecasts for growth and inflation remain too high despite recent downgrades. Our base case is that ECB policy interest rates will remain on hold through to the end of 2020 and that reinvestments will continue to the end of 2021. Second, we think that the ECB will announce relatively easy terms on the new TLTRO-III in June. The pricing will probably be similar to TLTRO-II so banks can borrow at rates as low as the deposit rate if they meet certain lending benchmarks.

Beyond these steps, there is a rising chance the ECB will need to do more. There has been speculation that a tiered deposit rate system could open the door for further cuts in the deposit rate. We are not convinced by that at this stage. We think the ECB is looking into this issue now because it expects the current level of negative rates to last for much longer, rather than because it is looking to cut rates further. If rate cuts are off the table, then the ECB may revive what has been its main stimulus tool of choice over the last few years: QE. Indeed, we think the probability of QE-II has risen significantly, though it is not yet our base case. (Nick Kounis)

US Macro: Consumer still in good health – Retail sales rebounded strongly in March, unwinding the weakness seen at the turn of the year. Overall sales were up by 1.6% mom in March, following a 0.2% decline in February. Underlying trends look to be improving as well, with Q1 ex-autos & gas sales up by an annualised 2.7%, after being flat in Q4. Consumer fundamentals still look good. US aggregate real wages are running at rates of 3.5-4%, while consumer confidence is also at elevated levels. While employment growth will slow and the impact of higher interest rates still has to fully come through, we judge that consumer spending will be relatively resilient, which should limit the slowdown in the overall economy to around trend rates. (Nick Kounis)