Mixed euro-zone data persists
Euro-zone data has been mixed, and whilst we have seen some improvement in data such as a pick-up in retail sales, the majority of data remains weak, particularly with regard to survey data such as the PMI. Surveys of inflation expectations and also market-based measures remain close to record lows, making it difficult to see where price pressures in the economy might arise.
Inflation data also remains very soft, although a small pick up this month did take place, driven by volatile items such as Easter package holiday prices. We believe inflation data will continue to remain soft in the coming months, led by a 6% stronger euro relative to last year and negative energy price inflation.
Tomorrow’s ECB meeting – exactly one year on from the sell-off with yields at exactly the same level, in our view Draghi will want to ensure there is no chance of history repeating itself
In March 2015, the ECB began buying government bonds as part of their quantitative easing (QE) programme. By April the German 10Y government bond had reached 0.07%. However, over the following month yields jumped 70 basis points. This year in March, the ECB increased the size of their government bond QE programme and the German 10 year bond has once again bottomed at 0.07%. Tomorrow, the ECB meeting and press conference will take place, exactly one year on from the sell-off, with yields at exactly the same level.
Reintroduction of possible interest rate cuts, ‘talking down’ of the euro, surprise could be talk of tiering interest rates
Our expectation is for Mario Draghi to maintain the dovish tone struck at the last meeting, which saw the ECB introduce a comprehensive package of easing measures, including the addition of a new non-financial investment grade corporate bond QE programme and the launch of a new targeted longer-term refinancing operations (TLTRO) programme which could, in principle, pay banks to borrow.
Draghi’s opinion voiced at the previous meeting expressed his expectation that further rate cuts would not be required, a view taken by the market as a pledge to keep rates unchanged. This has led to a strengthening of the euro in recent weeks to new 16-month highs1. This move, and any further move in the currency, would be extremely unwelcome in our view, especially with core inflation still standing at worryingly low levels of 1% and market and survey inflation expectations close to record lows.
As a result of this, our expectation is for a clarification by Draghi of these comments, a reintroduction of the possibility of interest rate cuts and in turn a ‘talking down’ of the euro. In our view, there are a handful of other moves to watch out for. These include further information on the corporate bond QE programme set to start in two months’ time – a programme which, up until now, remains unclear in terms of mechanism, size, or how purchases will be implemented. Finally, one big surprise could be talk of tiering interest rates, a similar mechanism to that seen in other countries that currently implement negative rates. The ECB had previously deemed this measure too complex for introduction.
In terms of the outcome of the meeting, Draghi will want to ensure there is no chance of history repeating itself.
1Bank of England data, peak level achieved on 7 April, 2016
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