ECB View: Officials evoke experience of Japan – ECB officials that backed the central bank’s stimulus package warned of the growing risks to the economic outlook. Ignazio Visco, the Governor of the central bank of Italy, said that ‘the economic situation is worse than we imagine and therefore we cannot risk losing control of inflation expectations’. He added that ‘we cannot ignore the more serious risk which is deflation in a situation of high public debts’. Meanwhile, Olli Rehn, Governor of the central bank of Finland asserted that the ECB ‘should take care to avoid the sort of harmful equilibrium that arises from prolonged low inflation and zero interest rates, as this would significantly constrain the capacity for monetary policy to balance the economic cycle’. As this situation ‘would bring about a lengthy shortfall in economic growth with respect to its potential and hinder efforts to boost employment’. He added that the inflation outlook is very subdued and that the medium-term inflation rate is seen clearly below the ECB target. Finally, Luis de Guindos, ECB Vice President, continued the theme. He said risks are tilted to the downside and noted that the ‘level of economic activity in the euro area remains disappointingly low’. He noted that Japan is a lesson of how it can be hard to escape a vicious cycle, saying that ‘policy rates will likely remain low, by historical standards, and may hit their lower bounds more frequently than in the past’. Against this background, he repeated calls for fiscal stimulus, asserting that it was of ‘utmost importance that we enhance the firepower of euro area stabilisation policy by means of a policy mix that, while continuing to make full use of monetary policy, assigns a more substantive role to fiscal stabilisation policy’.
These dire warnings come against the background of weakening economic data on both sides of the Atlantic (see below), with the weakness in manufacturing and trade spreading to services and domestic demand. At the same time, market-based measures of inflation expectations have fallen further. We continue to expect the ECB to step up the pace of monetary stimulus in the coming months. (Nick Kounis)
US Macro: Slowdown spreads to services – The ISM Nonmanufacturing Index (NMI) fell to a three year low of 52.6 in September, down from 56.4 in August, and well below our (54.5) and consensus (55.0) estimates. The fall was fairly broad-based among sub-indices, but particularly concerning was the drop in Employment (to 50.4 from 53.1) and New Orders (to 53.7 from 60.3) indices, which suggests weak confidence in the manufacturing sector – linked to the trade war – is spreading to the services sector. While the relationship between the NMI and services activity (observed for instance in private consumption growth) is not as strong as the relationship between the manufacturing PMI’s new orders index and business investment, directionally it does suggest a slowdown in services is on the horizon. This is consistent with our view that the weakness in manufacturing will ultimately drive a broader slowdown – via slower jobs growth, and in turn consumption. Markets have reacted accordingly, with OIS forwards moving closer to our expectation of two more Fed rate cuts this year; an October cut is now 88% priced (previously 80%), and an additional December now 72% priced (previously 60%). (Bill Diviney)
Euro Macro: Economy enters stagnation – The volume of retail sales in the eurozone grew by 0.3% mom in August, following a decline by 0.5% the month before. The 3m-o-3m growth rate increased from 0.2% to 0.5%, which suggests that sales will have expanded during the third quarter as a whole. Meanwhile, new car registrations probably also increased during Q3, with the 3m-o-3m change up from 2.1% in July to 5.7% in August. The combination of changes in retail sales and car registrations tends to track changes in total private consumption growth relatively well. The data for July and August indicates that private consumption grew at a modest rate of around 0.2-0.3% qoq in Q3, following 0.2% qoq in Q2. The modest expansion in private consumption growth is part of a broader trend of the weakness in exports and industry that started more than one-and-a-half years ago, spreading to domestic demand and services. Indeed, the services sector PMI for September was revised lower to 51.6, from a preliminary estimate of 52.0, while the forward looking new business component of the survey was revised downwards as well. Due to the revision in the services sector PMI, the composite PMI declined to 50.1 in September (preliminary estimate 50.4), a level that is consistent with stagnating GDP. (Aline Schuiling)