ECB Preview: TLTRO to be priced at -0.4%, while dovish tone should leave door open to further stimulus – The focus of this week’s Governing Council meeting will be on: (i) the details of the TLTRO-III (ii) the ECB’s views on whether action is needed/will be taken to alleviate adverse effects on the banking system of negative rates (iii) how it sees the overall outlook and hints at the prospect of further stimulus in coming months.
TLTRO-III – We expect the conditions for TLTRO-III to be very similar to TLTRO-II. That means that the lending rate on the programme could be as low as -0.4% if certain lending benchmarks are met. The size of the programme will again be 30% of eligible loans (total ex. mortgages) excluding current TLTRO loans. For the eurozone banking sector as a whole, that would mean that around EUR 980 bn extra can be borrowed, though the net amounts for Italian banks (EUR 31bn) and Spanish banks (EUR 43bn) are relatively modest.
Negative rates – We think the ECB will conclude that negative interest rates are currently not having adverse effects on bank lending conditions. In addition, a tiered deposit rate is a complicated system given the large variation of excess liquidity across banks in the eurozone. So we do not expect any measures to alleviate adverse effects on the banking system of negative rates.
Outlook and fresh stimulus – Although revisions to the ECB macroeconomic staff forecasts are likely to be modest (see below), we think that the central bank will sound more concerned about downside risks to the outlook and the tone will be dovish. This reflects the re-escalation of the trade conflict, as well as falling inflation expectations, which are questioning the credibility of the ECB’s price stability goal. The ECB should again stress that it is ready to adopt further monetary stimulus against this background. We think that more significant macro downgrades (to GDP and core inflation forecasts) are likely in the coming months, which will trigger more dovish shifts from the ECB. Ultimately, the ECB will need to do more against the background of weak growth, subdued inflation and falling inflation expectations.
Modest downward revision to growth outlook in June – The ECB will publish its new staff macroeconomic projections for the euro area. In its March projections it expected GDP to grow by 1.1% on average this year and by 1.6% in 2020. Since then, growth for 2019Q1 has been published and it came in at 0.4% qoq, which is twice as high as in the ECB’s quarterly growth projections. Nevertheless, the central bank will probably keep its expectations for growth in 2019 as a whole unchanged, while it could lower its forecast for 2020 somewhat. Importantly, the jump in growth in Q1 was largely due to one-off factors, which will be followed by payback in Q2. Moreover, the ECB’s currently projects a noticeable improvement in net exports in 2020, which has become less likely considering the recent re-escalation of the global trade tensions. Finally, the variables for which the central bank makes technical assumptions (interest rates, exchange rates and oil prices) have changed in a way that could raise the ECB’s forecast for headline inflation (not core inflation) a bit, which would lower the forecast for private consumption slightly. (Nick Kounis & Aline Schuiling)
US Macro: Manufacturing weakens further…more to come – The ISM manufacturing PMI fell to 52.1 in May, the lowest since October 2016. A modest rise in new orders and new export orders was more than offset by a further drop in the production index to 51.3 from 52.3, suggesting the manufacturing sector has continued to weaken in Q2 after an already soft Q1. While optimists might draw comfort from the slight (1-point) rise in the forward-looking new orders component, at 52.7 the index remains well below the post crisis average of 57.2, suggesting a weak outlook for investment. Moreover, the report reflects responses gathered prior to the latest threat from President Trump to impose tariffs on Mexican imports. In light of this threat, we are currently reviewing our scenarios for global trade, and expect to downgrade our US economic growth forecasts in the coming days (currently 2.3% for 2019, and 1.9% for 2020). (Bill Diviney)