ECB View: Fundamental arguments for further easing remain strong – We now expect the ECB to cut its deposit rate by 10bp in March, rather than in December. Our base case remains that the central bank will step up net asset purchases to EUR 40bn from April onwards, with the decision also likely at the March Governing Council meeting. As such, the ECB will once go for a package of measures, and this could eventually supplemented by – for instance – a further increase in the maturity of the TLTROs.
The case for the ECB to delay the deposit rate cut to March rests on a number of pillars. First of all, the Governing Council may want to have more information about the impact of September’s rate cut given concerns about the adverse impact of more deeply negative interest rates. Second, GDP growth slightly exceeded the ECB’s expectations in Q3, while it may also judge that downside risks related to the trade conflict and a hard Brexit have eased somewhat. Third, it is Christine Lagarde’s first monetary policy meeting as President and she will be leading a divided Governing Council. Although the opposition to the September package did not centre around a rate cut, further stimulus so soon after the last round might be contentious. Finally, a December rate cut has been fully priced out by financial markets and there has been no recent attempts by officials to push against that.
Nevertheless, the case for further monetary stimulus remains strong in our view. At the September Governing Council meeting, the ECB staff published forecasts showing that inflation would be at just 1.5% by the end of 2021, which is not consistent with the price stability goal. The stimulus provided by the September package was meant to lift inflation closer to the goal. However, developments have since gone the other way. Indeed, the GDP-weighted eurozone 10y bond yield is almost 30bp higher than at the time of the September meeting. This partly reflects investor disappointment at the scale of the September stimulus.
So the December projection for inflation in 2021 will still show 1.5% – at best. Indeed, recently the European Commission published new forecasts showing it expected inflation to be 1.3% at the end of 2021. The ECB may try to window dress the situation – as it has done in the past – by publishing a more bullish forecast for the following year. Indeed, in December, the ECB will for the first time publish projections for 2022. However, this strategy is losing credibility and this is reflected a disanchoring of various measures of inflation expectations. Finally, we continue to see GDP growth and inflation disappointing current ECB estimates. (Nick Kounis & Aline Schuiling)
Euro Fixed Income: Early QE data suggest shift to private sector – The Eurosystem published the weekly figures of its net asset purchases under its Asset Purchase Programme (APP). The figures included purchases during the first full trading week since the central bank restarted net asset purchases. The data suggest that the share of covered bonds and corporate bonds is higher than their average share in the APP during 2018, while that of the PSPP is significantly lower. Indeed, the share of the PSPP was 53% last week (2018: 76%), while that of the CSPP was 33% (2018: 15%), and the CBPP3 had a share of 14% last week compared to 7.5% during 2018. This would imply quite a shift in focus of the net asset purchases, although one must bear in mind that its too early to draw any firm conclusions from one week’s figure.
Meanwhile, the EUR 8.4bn of overall net purchases last week was also relatively high, as the central bank needs to buy on average around EUR 5.7bn per week in order to service the EUR 40bn of net asset purchases before year-end (bearing in mind that the central bank will temporarily halt APP purchases from 19 December). As such, it seems that it is already frontloading purchases in anticipation of slowing market activity in coming weeks. If these trends continue, the central bank would provide significant support for both the corporate bond and covered bond markets near term, though it is too early to draw strong conclusions. (Joost Beaumont)
UK Macro: Recession dodged, but fundamentals are weak – UK GDP grew 0.3% in the third quarter, a bit weaker than consensus (0.4%) but better than our forecast (0.1%). As we had expected, business investment contracted for the second consecutive quarter, while private consumption picked up a notch to 0.4%, from 0.3% previously – still well below the pre-referendum period, when consumption was growing at 0.8% qoq on average. The positive surprise came in net exports, which made a significant contribution of 1.2pp, following a 2.5pp contribution in Q2. This strength looks unsustainable, and we expect payback in the coming quarters.
More importantly for the medium term outlook, UK macro fundamentals are very weak. Investment has essentially been at a standstill for the past two years, as businesses remain paralysed by Brexit uncertainty. Things are scarcely better on the household side; while consumer confidence has held up better than business confidence, and real wage growth has picked up, household balance sheets are in a parlous state, with household debt not far off pre-recession highs at 90% of GDP, and the savings rate just shy of historically low levels. This makes households highly vulnerable to any downturn. With that said, both major parties in the coming election are promising big increases in government spending over the coming years, and as such, near-term growth should see support from a bigger fiscal impulse, whatever the outcome. All told, we continue to expect growth this year of 1.2%, and for this below-trend rate to be maintained in 2020. (Bill Diviney)