ECB View: Account reveals heightened concerns about inflation – ECB President Mario Draghi has a reputation (rightly or wrongly) of running ahead of the Governing Council when it comes to big policy shifts. Indeed, following his remarks at Sintra – where he strongly hinted at a new round of ECB easing – there were press reports that other Governing Council members were surprised by his comments. However, the account of the ECB’s June monetary policy meeting, which was pre-Sintra, suggested that the majority of the Governing Council stands firmly behind the President. The account notes that ‘there was broad agreement that, in the light of the heightened uncertainty, which was likely to extend further into the future, the Governing Council needed to be ready and prepared to ease the monetary policy stance further by adjusting all of its instruments, as appropriate, to achieve its price stability objective. Potential measures to be considered included the possibility of further extending and strengthening the Governing Council’s forward guidance, resuming net asset purchases and decreasing policy rates’. There seemed to be particular concern about the inflation outlook. In particular, although inflation was projected to rise in coming years it ‘was still projected to reach only 1.6% in 2021, which was seen to remain some distance away from the Governing Council’s inflation aim’. Against this background it was important to prepare for ‘adverse contingencies’.
At the July meeting we think the Governing Council will decide to change its forward guidance on policy rates to explicitly hint at the possibility of rate cuts. In particular, it could say it expects the key ECB interest rates ‘to remain at their present levels or lower …’. In September, we expect a 10bp cut in policy rates as well as a clear signal that the ECB is investigating the design of a new asset purchase programme. By December, we expect the ECB to announce a EUR 630bn QE package, to be implemented for 9 months from January 2020 at a pace of EUR 70bn per month. The second 10bp rate reduction will follow in Q1 of next year. (Nick Kounis)
US Macro: Transitory drags partially unwind, but underlying inflation still muted – Core CPI inflation surprised to the upside in June at 0.3% mom, higher than our and consensus forecasts (0.2%). Annual inflation picked up to 2.1% from 2.0% in May. This was the first upside surprise to inflation since January 2018, but it followed four consecutive downside surprises over Feb-May. The details showed the bulk of the strength in areas that have been widely flagged as transitory drags on inflation recently, such as apparel, as well as a recovery in used cars after months of weakness. Services inflation is still going nowhere – consistent with essentially flat unit labour cost growth. All told, while the Fed will feel some relief following the persistent weakness in inflation, this month’s numbers will do nothing to change the calculus for rate cuts, in our view. Underlying inflationary pressure remains muted, and unit labour cost growth will need to pick up before we can expect a meaningful acceleration on the horizon. As such, we continue to expect the Fed to cut rates by 25bp at the 30-31 July FOMC, followed by two further 25bp cuts by Q1 2020. For a more detailed analysis, see our US Watch: What’s up with inflation? published last week. (Bill Diviney)