ECB View: President steps up the rhetoric on bond yields – ECB President Christine Lagarde made comments reminiscent of Mario Draghi’s ‘whatever it takes …believe me it will be enough’ speech at the height of the euro crisis. In an interview on Bloomberg TV earlier today, she said that bond investors ‘can test us as much as they want’ referring to the ECB’s commitment to keep government bond yields low. She went on to assert that the Governing Council ‘has exceptional tools to use at the moment, and a battery of those. We will use them as and when needed’. The market reaction to Ms. Lagarde’s comments were however far from reminiscent of how yields reacted to former President Draghi’s speech in 2012. Bond investors seem to be taking a ‘show me the money stance’ against the background of an underwhelming step up of PEPP purchases so far and upward pressure on European yields from the US reflation trade. There is question mark about whether the ECB’s ‘bark is worse than its bite’.
So is the ECB serious and what could it do next? On balance we do think the ECB is serious about capping bond yields. It would not make much sense for it to have drawn a line in the sand at the last Governing Council meeting and then repeatedly double down. The Governing Council also has a history of dragging its feet but delivering eventually. Well, at least in terms of policy actions…but in terms of inflation, not so much. Indeed, core inflation fell further in the flash estimate for March, underlining the ECB’s view that inflation would significantly undershoot its target in both 2022 and 2023.
The ECB’s policy options are indeed broad. Firstly, it could continue on its current trajectory but accelerate asset purchases under the PEPP much more significantly. Last year during the height of the crisis, net purchases averaged 30bn a week, compared to roughly EUR 20bn over the last weeks.
Secondly, the ECB could re-enforce the step up in the pace of net purchases by increasing the size of the PEPP envelope. Indeed, the ECB President noted in the interview that ‘we will certainly adjust as needed’. However, this might me not be pressing given there is still a large amount left in the PEPP envelope (around EUR 900bn). Alternatively, the ECB could increase the monthly APP purchase pace, as this programme is seen as lasting longer than the PEPP, and this could send a message of prolonged policy support.
Third, the central bank could enhance its forward guidance on policy rates. It could move to a date-based guidance on how long policy rates will remain on hold with the aim of signalling that markets are pricing in a lift off that it judges to be too early. An alternative would be to extend the minimum PEPP period through 2022. This would signal a longer period of support but also underline a long period of unchanged policy rates (as it is understood that policy rates will not go up until purchases end).
Finally, the ECB could cut its deposit rate. This would also be a way to drive down the market’s policy rate expectations. Such a move could be complemented with a rise in the tiering multiplier to reduce the direct cost of the measure for banks.
Our baseline is that the ECB will persist with a policy of accelerating weekly PEPP purchases. However, if this does not prove effective, its next step will likely be strengthening forward guidance. Beyond that it has the option of either raising the PEPP envelope or cutting its deposit rate further. Up until now, we have seen an increase in the PEPP envelope as being the most likely alternative to the current course.
However, the ECB’s Executive Board may find it easier to get support from the more hawkish Governors for a deposit rate cut. In addition, a deposit rate cut might have a more powerful and persistent impact on bond yields. This reflects that the single most important driver of long rates is short rate expectations over the coming years. We therefore judge that a deposit rate cut has become more likely, though we are not yet sufficiently convinced to make it part of our base line. We will be monitoring the effectiveness of the PEPP in anchoring yields and official commentary in the coming time to get a better sense of whether a rate cut could be on the cards. (Nick Kounis)
China Macro: Jump in Services PMI shows post LNY demand recovery – China’s National Bureau of Statistics published the ‘official’ purchasing managers’ indices (PMIs) earlier today. The most eye-catching outcome was the much stronger than expected rise (by almost five full points) of the non-manufacturing PMI to 56.3 (February: 51.4, consensus: 52.0). This follows a slide in the three previous months and brings this index back to the levels seen in October/November 2020. Since December 2020, the recovery of China’s services sectors from the pandemic shock had lost some ground, due to virus flare ups and a tightening of mobility restrictions that particularly hit the transport and hospitality sectors again. These measures particularly had an effect around the annual Lunar New Year holiday period (this year scheduled mid-February). Traditionally, around a third of the population travels to their home towns in this period, but this year strict government policies had prevented such large-scale movement. The rebound in the non-manufacturing PMI suggests that consumption demand for services has recovered from the Lunar New Year-related slowdown, while construction also showed renewed strength.
Meanwhile, China’s official manufacturing PMI came in stronger than expected as well, rising back to 51.9 (February: 50.6, consensus: 51.2) and also returning to end-2020 levels. The improvement of this index was broad-based, with for instance the new orders, new export orders and employment components all improving. The export sub index, which had fallen to below the neutral 50 mark (48.8) in February, rose by 2.4 points to a three-month high of 51.2. While this improvement suggests that external demand is recovering, it could also be an indication of some easing of export capacity constraints related to logistical bottlenecks in global shipping that are concentrated in Chinese ports. At least, after having risen sharply since November 2020, container freight rates from China’s ports have started easing from their end-January peaks in recent weeks. All in all, the improvement of China’s PMIs as we head into Q2 is in line with our base case, in which we expect a pick-up in growth momentum after a relatively weak first quarter of the year. (Arjen van Dijkhuizen)