Global Daily – Lagarde strikes dovish tone

by: Nick Kounis , Aline Schuiling , Arjen van Dijkhuizen

ECB View: Lagarde notes that weakness has spread, while inflation remains a concern –  ECB President Christine Lagarde struck a dovish tone in remarks at a hearing of the Committee on Economic and Monetary Affairs of the European Parliament. She noted that the outlook for the global economy remained ‘sluggish and uncertain’ and that this was weighing on investment and exports, with the manufacturing sector slowing the most due to these developments. At the same time, she noted that the weakness was spreading saying that the Governing Council was ‘seeing signs of spillovers to other parts of the economy, with recent survey data pointing to some moderation in the services sector’. The weakness in the economy had ‘been affecting price developments, which remain subdued’ and she added that ‘inflation expectations are at or close to historical lows’. Against this background she talked up the effectiveness of the ECB’s tools saying that ‘monetary policy can respond effectively even when growth is being dampened by external factors’. She asserted the ECB remained ‘resolute in its commitment to deliver on its mandate’ and added that ‘monetary policy will continue to support the economy and respond to future risks in line with our price stability mandate’. We think her comments are consistent with our view that the ECB will announce a second stimulus package in the coming months (most likely in March of next year).

Meanwhile, Ms. Lagarde also discussed the ECB’s intention to ‘review our strategy and to consider how our monetary policy can best deliver on our mandate’. She said it was premature to discuss the precise scope of the exercise but did note that central banks had been struggling with ‘how to best define the medium-term objective of monetary policy, so as to ensure that expectations are firmly anchored’ and that this could be especially helpful today when ‘policy space to buffer the economy from adverse developments is more limited than it was prior to the crisis’. It seems to us that this definition of the issues suggests that the ECB would be minded to opt for a more ambitious and clear inflation goal that could push inflation expectations up rather than down. Having said that, there is a lot of disagreement on the Governing Council on this topic, which could limit progress. Finally, the ECB President hinted that the review could take a while to complete, saying that it would require ‘ time for reflection and for wide consultation’. (Nick Kounis & Aline Schuiling)

China Macro: Improving PMIs versus weak hard data – The PMIs for November published over the past few days showed a clear improvement. The official manufacturing PMI published on Saturday rose to an eight-month high of 50.2 (October: 49.3, consensus: 49.5) and the non-manufacturing PMI jumped to 54.4 (October: 52.8, consensus: 53.1). On Monday, Caixin’s manufacturing PMI came in at 51.8 (October: 51.7, consensus: 51.5), the highest reading since 2016. Caixin’s PMI – with a relatively strong coverage of the private sector – started rising back in July, possibly reflecting that Beijing’s piecemeal easing campaign is targeted at the private sector. While the PMIs suggest growth momentum is improving, the latest hard data (for October) were not encouraging. Industrial production growth fell back to 4.7% yoy. Growth of retail sales dropped to 7.2% yoy, the weakest pace since 1999. Fixed investment slowed to 5.2% yoy, the lowest number on record. Growth of imports and exports also remained in negative territory, new lending volumes came down and industrial profits reached the weakest number since 2011 (-9.9% yoy).

The discrepancy between improving business confidence and weak hard data does seem to be, at least in part, related to the (twists and turns in the) US-China conflict. The export sub index in the latest official PMI survey rose by almost two points, possibly supported by rising expectations that the tariff tit-for-tat has come to an end. That said, the Phase One deal announced in early October still has to be signed and many uncertainties remain, for instance on how much rollback on existing tariffs could be agreed on and under what conditions (such as an enforcement mechanism). All in all, assuming no further stepping up in US-China tariffs, we expect a bottoming out in industry next year. That will help the Chinese economy stabilise: we expect official GDP growth to slide only marginally to 5.8% in 2020, from 6.0% yoy seen in Q3-2019. (Arjen van Dijkhuizen)