Global Daily – Losing faith in the ECB

by: Nick Kounis , Bill Diviney

ECB View: Professional forecasters judge ECB will miss its inflation goal – The ECB’s Survey of Professional Forecasters would have made grim reading in Frankfurt. The survey showed that economists further revised down their expectations for inflation two-years ahead. They now see inflation at 1.4% over that horizon, down from 1.5% in the last reading in Q3. Meanwhile, long-term expectations – 5 years ahead – remained stuck at 1.7%, which compares to the 1.9% definition of price stability communicated by ECB President Mario Draghi. The probability around these point estimates remained tilted to the downside in both cases. Indeed, forecasters attached a 40% probability of inflation being below 1.4% over 5-years, the highest in the survey’s history. These results are broadly in line with financial market pricing. Inflation options suggest investors attach more than a 70% probability of inflation at 0-1.5% two-years ahead, while the 5y5y inflation swap is not far off historical lows (it stood at 1.23% at time of writing).

These outcomes are particularly striking, given that they come after the ECB announced a package of monetary stimulus measures at the September Governing Council meeting. Although this may reflect scepticism about the ECB’s ability to raise inflation against the background of global economic weakness, it likely also reflects that economists and investors are unimpressed by the size of the package and the divisions in the Governing Council, which could trigger scepticism about the ability of the ECB to act decisively going forward.

A disanchoring of inflation expectations is a key concern for central banks, as low inflation expectations can impact wage and price setting behaviour, which would keep inflation stuck at low levels. The weakness in macro data since the September Governing Council meeting combined with deteriorating inflation expectations suggests that the ECB will step up monetary stimulus in the coming months. (Nick Kounis)

UK Politics: Election likely to be called this week – Following confirmation of the Brexit delay to 31 January by European Council President Tusk today, the government will hold a vote on triggering a general election. Under the Fixed Term Parliaments Act (FTPA), an early election can only be triggered by a 2/3 majority of MPs. Under this proposal, there would be a further attempt to pass PM Johnson’s new deal with the EU in the next two weeks, with an election to follow on 12 December. With the opposition Labour Party signalling it will vote against today’s motion, we doubt an election will be triggered immediately. However, the Liberal Democrats and SNP have proposed their own path to an election, which would be somewhat earlier, on 9 December, and would bypass both the FTPA (requiring just a simple majority) and passage of PM Johnson’s deal. This approach would probably be more politically advantageous to the opposition (as it removes the chance of a parliamentary ‘win’ for the government pre-election), and looks more likely to succeed. One way or another, the UK looks to be heading for a general election, with the LD/SNP proposal to be voted on sometime between tomorrow and Thursday.

Polls suggest a Conservative victory, but it’s not so clear-cut – The Conservatives currently enjoy a 10-15 point lead in opinion polls over their nearest rival, the Labour Party. However, the party enjoyed a similar lead over Labour in the period leading up to the 2017 election, and this proved disastrous for the Conservatives, with the party losing its majority in parliament. The coming election’s predictability is further complicated by the UK’s first-past-the-post electoral system – a ‘winner takes all’ system where parties can win seats with a minority of the vote share in a given constituency, so long as they have the most votes. This did not pose problems when elections in the UK were two-horse races between right/left, Conservatives/Labour. However, the Lib Dems (pro-remain) and Brexit Party (pro-no deal Brexit) have both attracted voters from the main parties, and so extrapolating national polling to the constituency level could yield misleading predictions of the actual outcome. With that said, of the likely scenarios – a Conservative majority, another hung parliament (similar to now), or a ‘Remain alliance’ (Labour and LibDem) victory – all lead to relatively benign outcomes for financial markets. The Conservatives will campaign on the basis of their deal (whereas the risk before was that they would campaign for a no-deal Brexit), and another hung parliament or Remain alliance victory would likely lead to another referendum pitting PM Johnson’s deal (or some soft Brexit variant) against Remain. In any case, the risk of a no-deal disorderly Brexit is substantially lower than it was previously. (Bill Diviney)