Investment Research General Market Conditions Preview: on autopilot Pernille Bomholdt Henneberg Chief Analyst +45 45 13 20 21/+44 20 7410 8157 perni@danskebank.com 24 April 2017 www.danskemarketsequities.com Important disclosures and certifications are contained from page 12 of this report
preview: on autopilot with its monetary policy We expect a slightly dovish tone from Mario Draghi at this week s meeting, as the main message should be that the is on autopilot with its current monetary policy. Draghi has recently said a reassessment of the current monetary policy stance is not warranted at this stage (see speech) and we expect him to reiterate this, which should be perceived as dovish. Following the latest meeting, speculation about the sequencing of the s exit from the very accommodative monetary policy increased and a month ago the market priced a 10bp deposit rate hike this year. Now the pricing of the hike has been postponed to late 2018, after prominent members expressed a dovish view, thereby dampening market participants expectations. In our view, the recent dovish tone reflects the s perception of the pricing of hikes as a tightening of the financial conditions, which it considered as unwarranted. Despite the expected dovish communication at the upcoming meeting, we believe the could change its forward guidance on policy rates at the meeting in June. However, there is a risk that the will also take a more cautious approach at the meeting in June, as Draghi has recently said Before making any alterations to the components of our stance interest rates, asset purchases and forward guidance we still need to build sufficient confidence that inflation will indeed converge to our aim (see speech). We still believe the will announce an extension of its EUR60bn monthly QE purchases at the September meeting and hence continue the purchase programme in 2018. 2
preview: on autopilot with its monetary policy 1. Reassessing the current monetary policy stance is not warranted 2. The dampened market s speculation on rate hikes 3. Speculation that the will address the repo issues 3
#1. Reassessing the current monetary policy stance is not warranted Reassessing the current monetary policy stance is not warranted We still expect to continue QE in 2018 Recently, Draghi communicated that the has not yet seen sufficient evidence to alter materially the assessment of the inflation outlook and related to this, the has continually said there are no signs yet of a convincing upward trend in underlying inflation. In the minutes from the latest meeting, it was said that the linchpin for higher underlying inflation was a turnaround in wage dynamics. In our view, the is very optimistic in its wage growth projection and with a lowering of the forecast we expect the to announce an extension of QE purchases into 2018. Inflation expectations at QE announced levels Source:, Eurostat, Danske Bank Markets 4
#1. Reassessing the current monetary policy stance is not warranted Low core inflation as long as wage growth stays low Higher wages linchpin for rising core inflation Philips curve: s wage forecast is hopeful 2019 Wages: 2.4% Unemp: 8.4% 2018 Wages: 2.1% Unemp: 8.9% 2017 Wages: 1.8% Unemp: 9.4% 2016 Wages: 1.3% Unemp: 10.0% Source:, Eurostat, Danske Bank Markets Source:, European Commission, Eurostat, Danske Bank Markets 5
#1. Reassessing the current monetary policy stance is not warranted The usually forecasts higher core inflation The has long expected higher inflation usually forecasts higher core inflation Source:, Eurostat, Danske Bank Markets Source:, Eurostat, Danske Bank Markets 6
#2. The dampened the market s speculation on rate hikes The dampened the market s speculation on rate hikes Core inflation is set to stay low this year The hawkish message at the latest meeting (see Review: Hawkish twist but full QE implementation is needed, 9 March) resulted in the market pricing in a 10bp deposit rate hike at the end of this year. This then resulted in prominent members dampening market participants expectations with a dovish communication that postponed the pricing of the hike to late 2018. In our view, the pricing of hikes from is very premature as the inflation outlook should not be strong enough to tighten the monetary policy this year. Another argument for hiking rates could be that banks were suffering after the long period of negative policy rate but it does not seem to be the case that the wants to hike just to support the banking sector. A depo rate hike was priced already this year 40 bp 35 30 25 20 15 10 5 0-5 May-17 dated Eonia swaps (assuming neutral Eonia is 5bp above deposit rate) Jul-17 Nov-17 Jan-18 May-18 Source:, Eurostat, Danske Bank Markets Aug-18 Oct-18 Jan-19 Apr-19 Current pricing (21-Apr-17) pricing (21-Mar-17) pricing (22-Feb-17) 7
#2. The dampened market s speculation about rate hikes German banks are mainly paying for s negative deposit rate German banks mainly pay for negative depo 35% 33% Deposits at national central bank in % of total Eurosystem deposits Bank stocks are not sending warning signals 30% 25% 23% 20% 15% 12% 10% 5% 0% 6% 6% 6% 5% 5% 3% 1% 0% 0% 1% 0% 0% 0% 0% 0% 0% DE FI NL LU AT FR BE IE ES IT PT GR CY EE LV LT MT SK SI Core 54% Semi-core 33% Periphery 6% Others 7% Source:, European Commission, Eurostat, Danske Bank Markets Source:, European Commission, Eurostat, Danske Bank Markets 8
#2 The dampened market s speculation about rate hikes Not clear that banks need support from the hiking rates German and Italian banks under great strain Italian banks have low interest rate margins 160 Net interest income 140 120 100 80 60 40 2008 2009 2010 2011 2012 2013 2014 2015 Portugal Spain Italy France Germany Source: European Commission, Eurostat, Danske Bank Markets Source: Eurostat, Danske Bank Markets 9
#3. Speculation that the will address the repo issues Speculation that the will address the repo issues The focuses on the repo issues At the latest meeting in March, Draghi said the was monitoring distortions on the very short-end German yield curve and last week, the published a survey on credit terms and conditions in eurodenominated securities, which said that the liquidity and functioning of markets for the underlying collateral deteriorated, on balance, for nearly all types of eurodenominated collateral, although the deterioration was most pronounced for government bonds (see survey). This fuelled speculation that the could address the repo issues at its upcoming meetings, for instance by lending out more of the collateral held by the eurosystem and/or easing the conditions. German yield curve affected by s QE Source:, Danske Bank Markets 10
#3. Speculation that the will address the repo issues s purchase pattern one of the forces behind the repo issues Maturity of German purchases has fallen purchase pattern drives German yields Source:, Danske Bank Markets Source: Bloomberg, Danske Bank Markets 11
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