ECB View: Risks that action will come earlier – Comments from ECB officials over the last few days seem to suggest that the balance of risks to our base case for monetary easing are tilted towards earlier rather than later moves. Benoit Coeure said in an interview to BFM business radio that monetary policy needs to be accommodative ‘more than ever’ adding that the central bank could cut interest rates and restart net asset purchases ‘if needed’. Meanwhile, in a speech to the Bank of Finland conference last week, Chief Economist Philip Lane outlined that below-target inflation outcomes meant that the ECB needed to prove its commitment to price stability by taking relatively earlier action than if inflation outcomes had been closer to target. In particular, he asserted that in the current situation ‘it is essential that a central bank shows consistency in its monetary policy decisions by proactively responding to shocks that might delay convergence to the target or move inflation dynamics in an adverse direction’. Comments from Francois Villeroy de Galhau were a little more cautious. He said that policy easing would depend on data over the next ‘few months’ and noted that ‘we have several governing councils to come in the next months’. Still on balance we put more weight on the comments of Messers Couere and Lane as they are members of the Governing Council and the latter will be the one presenting views on the economic outlook and policy prescriptions to his colleagues.
Our base case for ECB easing and the timing of the moves is as follows. 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. However, the recent comments from officials suggest that the balance of risks are towards earlier moves. (Nick Kounis)
US Macro: The real story from the June payrolls was weak wage growth – After the upside surprise in the June payrolls – which saw net new job creation of 224k against 160k consensus expectations – expectations of a 50bp rate cut by the Fed this month have all but unwound; 27bp in cuts are now priced in by OIS forwards for the July FOMC, down from as much as 38bp two weeks ago. The market still very much expects a 25bp cut, however – and with good reason, in our view. Momentum in the economy continues to weaken amid significant uncertainty over trade policy, and inflationary pressure can best be described as muted, with risks of a de-anchoring in expectations. Against this backdrop, arguably the most interesting news from the June payrolls report was the continued surprise weakness in wage growth. Since the start of the year, hourly earnings growth has disappointed in 4 of 6 payrolls reports, while momentum in wage growth has fallen sharply – from a cyclical peak of 3.6% 3m/3m annualised last October, to 2.7% in June. This is helping to drive unit labour cost growth close to zero, thanks to a rise in productivity growth, and comes despite a further fall in the unemployment rate, from an average of 3.9% in Q1 to 3.6% in Q2. While it is hard to pinpoint a driver of softening wage growth, what we can say is that it suggests the ‘natural’ rate of unemployment (NAIRU) is lower – potentially much lower – than conventional estimates of 4.6% (CBO) and 4.2% (FOMC median). As a result, there is likely further room for the unemployment rate to fall, without significant inflationary pressure. This is something we argued in our Where is the wage growth? report last year, and it bolsters the case for Fed easing. (Bill Diviney)