Global Daily – ECB to open door to further downgrades

by: Nick Kounis , Aline Schuiling , Bill Diviney

ECB Preview: Growth and inflation are undershooting September projections – The ECB’s Governing Council meets later this week for its last monetary policy meeting under the leadership of Mario Draghi. Having announced a package of measures last month, any further action looks unlikely at this meeting. However, the case for additional stimulus remains strong and it will be interesting to see whether the ECB explicitly recognises recent weak data, which would set the scene for further revisions in December.

Indeed, while the ECB expects GDP growth of 0.1% qoq in Q3 and 0.2% in Q4, the PMI surveys were consistent with zero growth going into the fourth quarter. There are also reasons to be sceptical about the strength of the revival that the ECB sees in 2020, when quarterly growth averages 0.4% qoq. It is banking on a significant uptick in global growth, while assuming very limited spillovers to the domestic economy from the industrial recession. Meanwhile, headline inflation – at 0.8% yoy – is running below the ECB’s projection as well and looks  likely to head lower still.

The ECB’s midpoint projection shows inflation accelerating to 1.5% by the end of 2021, though that is still below its price stability goal (defined by Mr Draghi as 1.9%). The ECB seems to have put a lot of stock on the impact of its September package of measures to lift the outlook for economic growth and hence inflation to levels it finds satisfactory. However, bond yields are currently higher than what was assumed in the September projection.

Tempering these negatives, will be some easing of downside risks related to a no deal Brexit and a further escalation of the US-China trade conflict, following political progress in each case. However, overall we would expect the tone of the press conference to be dovish. The Governing Council is likely to recognise the possibility of further downward revisions and re-assert its commitment to step up monetary stimulus if needed.

Our growth and inflation expectations are below those of the ECB. We are factoring in a more prolonged slowdown. The weakening of industry and exports shows no signs of abating and is starting to impact labour markets, so there will be knock-on effects to consumer spending.

Inflation will more likely remain subdued rather than rising in the coming quarters. The cyclical slowdown in economic growth means that cost pressures are leading to margin compression rather than price rises, while cost pressures are (and should continue) to ease going forward as labour markets loosen. At the same time, there are structural downward pressures on inflation from digitilisation and a fall in inflation expectations.

We expect the ECB to cut the deposit rate by another 10bp in December before announcing a step up in the pace of net asset purchases at the March meeting. (Nick Kounis & Aline Schuiling)

UK Politics: Brexit deal vote on the backburner as focus shifts to delay – Parliament neither rejected nor voted in favour of PM Johnson’s deal at a historic sitting on Saturday, instead passing the so-called ‘Letwin amendment’, which states that parliament ‘withholds approval unless and until implementing legislation is passed’. This afternoon, Speaker John Bercow ruled that the government cannot bring the deal to a vote in parliament, given the circumstances have not changed since the amendment was passed. The Letwin amendment was designed to avoid an ‘accidental’ no deal Brexit, should the withdrawal agreement have been passed, but implementation scuppered by the failure of accompanying legislation – of which there is a significant amount. Given the tight timescale, it would indeed have been essentially impossible to pass all legislation in time and in accordance with normal parliamentary scrutiny.

Despite potentially having just about enough MPs on board with the deal (although it looks very tight), the government’s focus will now therefore be on complying with the Letwin amendment by introducing the supporting legislation necessary to implement the Withdrawal Agreement. In the meantime the European Council must decide on whether and how long it will grant a delay to Brexit, currently due to take place in just 10 days on 31 October. Despite attempts by the government and some pro-Brexit MPs to persuade the EU not to grant an extension, we expect an extension to happen, with the question only of how long it will be. While leaders have been tight-lipped, the German Chair of the Bundestag Foreign Affairs Committee (and CDU MP) Norbert Röttgen tweeted yesterday that “[the European Council] should now grant a final long [extension], giving the UK time to sort itself out & to prepare for all possible resolutions including a #SecondReferendum.” The last time PM May requested a Brexit delay of three months, one was ultimately granted for seven months; as such, it is quite possible a similarly long extension will now be granted, to avoid the need for further near-term delay requests.

The longer it takes for legislation to get through parliament, the higher the chance that MPs who have been won around to back the deal might get cold feet. This suggests a higher chance that the deal passes only with some amendments, probably along the lines of those proposed by the opposition Labour Party – of putting the deal to a referendum versus the option of remaining in the EU, and/or committing to entering a customs union with the EU once talks begin on the post-Brexit longer term relationship. Failing that, an election could be called once a delay to Brexit has been secured. In any case, we continue to view events as having essentially taken a disorderly Brexit off the table, meaning that any outcome is likely to be a benign one for financial markets. (Bill Diviney)