September 13th, 2018

ECB Geen categorie Morning Note

September ECB meeting: Draghi to remain tight-lipped on rate hikes

  • Since the July Governing Council meeting things haven’t gone the ECB’s way. In fact, the case for tightening has weakened, though not that it will deter the ECB from moving towards the first rate hike in the second half of next year (we’re still aiming for a September deposit rate hike only).
  • For starters, global activity growth has softened since the start of the year. The Markit global manufacturing PMI has been sagging, while word trade volumes according to the Dutch central planning agency have been weak. That’s a big problem for a large and open workshop economy like the Eurozone. The export share in GDP of the Eurozone was 47% last compared to just 12% in the US. Hence the slowdown trend you see in the global manufacturing PMI is mirrored in Eurozone survey data:


  • According to the European Commission’s monthly Economic Sentiment Index (a rival of the Markit PMI), the Eurozone economy entered slowdown territory at the start of the year (chart below).


  • And while the Sentiment Index is still consistent with soaring GDP growth, the more reliable GDP estimates according to the Markit PMI point to growth of just 1.6% this year. That’s barely above the potential rate of growth. The only positive here as that it could always have been worse; and that Trump’s “fire and fury” with regards to trade is aimed at China as autos and parts tariffs have been shelved. In fact, talks on a trade deal between the US and EU were rebooted yesterday.
  • Turning to inflation – price stability is what it’s supposed to be all about – two underlying measures of core inflation definitely seem to be on the rise. It has become clear that the year-on-year percentage increase in the so-called ‘super core’ measure of core inflation (which only includes items that are sensitive to the output gap) has been grinding higher since 2017. That same pattern also seems to be becoming visible in our preferred measure of core inflation, namely the one that includes non-energy and non-transport related services prices:


  • While one has to acknowledge the improvement in the more esoteric measures of inflation, plain old core inflation printed soft at 1.0%.
  • Bottom line? The data suggests there’s no need for Draghi & Co to bring forward interest rate hikes, or suggest markets tightening will happen sooner than priced in. And markets concur.
  • With the deteriorating outlook for growth, the Euro Stoxx 50 is down more than 5% since the July Governing Council meeting:


  • Banks in particular have taken a beating, shedding 8% since the meeting:


  • IG corporate bond spreads have widened further. In fact, in cash markets spreads are at their widest level since the start of 2017 as the end of net ECB buying of corporate bonds approaches:


  • Bund yields have been going nowhere, really:


  • The ECB will be relieved though that Italy is dropping from investors’ radar as the government has completely jettisoned outlandish fiscal plans (though on Wednesday Italy was making headlines once again, with reports of Finance Minister Tria’s resignation):


  • With the increasingly uncertain growth outlook, Draghi & Co will be relieved that real short rates remain deeply negative:


  • To conclude, expect another ‘we didn’t discuss that’ press conference, with Draghi offering no clues on the rate hike cycle that’s supposed to start roughly a year from now. Given the constellation of economic data and the state of play in markets, there’s reason enough for Draghi to remain tight-lipped. We could see Draghi throwing the analyst guild a bone by saying something along the lines that rate hikes will be gradual and that the ECB will be patient or whatnot, but that will be vague enough and shouldn’t disturb EONIA forward pricing much (pricing in lift-off in October and December, and annual rate hike pace of 25bps versus our forecast of September lift-off of deposit rate hike only and 40bps annual increase in policy rates).