Investment Research General Market Conditions ECB Preview On autopilot for now Aila Mihr Jens Peter Sørensen Christin Tuxen Sverre Holbek Analyst Chief Analyst Chief Analyst Senior Analyst +45 45 12 85 35 +45 45 12 85 17 +45 45 13 78 67 +45 45 14 88 82 amih@danskebank.dk jenssr@danskebank.dk tux@danskebank.dk holb@danskebank.dk 8 December 2017 www.danskebank.com/ci Important disclosures and certifications are contained from page 12 of this report
Summary: ECB on autopilot for now Following the decision to extend the QE programme for another nine months in 20, we do not expect the ECB to make any changes to its policy stance at its upcoming meeting. Instead, we think policymakers will put off any substantial discussion about the next move or changes to the forward guidance until well into 20. Activity indicators have remained strong and we expect the ECB to revise its growth and inflation forecasts upward in light of the ongoing strong economic momentum. Consensus seems to be growing in the Governing Council that the October QE extension was the last one, as the ECB is increasingly shifting towards a more holistic view of the economy and inflation. Based on this, we think it is important to watch developments in super core inflation. Other topics that could come up during the Q&A include the recent volatility in the Eonia fixing and the repo market over year end. We think it is likely that the corporate bond and covered bond purchase programmes share of QE will be increased from January 20. In our view, it is too early for the ECB to spur the next wave of normalisation pricing just yet, so we project EUR/USD within a 1.17-1.20 range near term. We expect the trend for tighter spreads and flatter curves in the euro fixed income market to continue. No changes to ECB s forward guidance (1) Level of policy rates The ECB expects key ECB interest rates to remain at present levels (2) Policy rates horizon for an extended period of time and well past the horizon of our net asset purchases. (3) QE magnitude Net asset purchases are intended to continue at a monthly pace of EUR30bn until the end of September 20, or beyond, if necessary (4) QE tapering condition and in any case until the Governing Council sees a sustained adjustment in the path of inflation consistent with its inflation aim. (5) QE flexibility If the outlook becomes less favourable, or if financial conditions become inconsistent with further progress towards a sustained adjustment in the path of inflation, we stand ready to increase the asset purchase programme in terms of size and/or duration. 2
ECB s dilemma: economy steaming ahead but inflation pressures staying subdued Growth has surprised on the upside in 2017 and PMIs point to more to come but rising underlying inflation pressure is still not in sight Core inflation at 0.9% for two consecutive months is clearly a disappointment for the ECB, which is likely to revise down its 2017 core inflation forecast as a consequence. Source: EC, Markit, Eurostat, Macrobond Financial, Danske Bank Source: Eurostat, Macrobond Financial, Danske Bank Aila Mihr, Analyst, amih@danskebank.com, +45 45 12 85 35 3
ECB December forecasts set to paint a rosier outlook for growth and inflation Growth Strong economic data in recent months and comments from ECB members point to an upward revision of the ECB s GDP forecast. Jens Weidmann: Evidence is mounting the economic outlook will be at least as good as previously forecast, if not even better. Yves Mersch: No-one would be overly surprised if we would again slightly revise upwards our projections for growth. Inflation We expect the ECB to revise up its inflation forecast for 20 due to higher energy price inflation driven by recent higher oil prices (see also Euro Area Research ECB inflation gap persists in 2019, 4 December). The new 2020 forecast will probably show a further pickup in inflation towards the target, driven by the ECB s belief in increasing underlying inflation pressures in the light of the continued strong economic momentum and a growing urge in the Governing Council to move ahead with monetary policy normalisation. Aila Mihr, Analyst, amih@danskebank.com, +45 45 12 85 35 2020 inflation forecast set to show inflation close to target Exp. ECB projections (December 2017) HICP inflation Core inflation GDP growth Unemployment rate Wage growth 2017 20 2019 2020 1.5% (1.5%) 1.0% (1.1%) 2.3% (2.2%) 9.1% (9.1%) 1.6% (1.5%) 1.3% (1.2%) 1.3% (1.3%) 2.0% (1.8%) 8.4% (8.6%) 2.0% (2.0%) 1.5% (1.5%) 1.5% (1.5%) 1.9% (1.7%) 8.0% (8.1%) 2.3% (2.3%) 1.8% 1.7% 1.7% 7.7% 2.4% Note: Parenthesis Figures are in parentheses old ECB are projections the old ECB (from projections September from 2017) September 2017 Source: ECB, Danske Bank 4
ECB shifting towards a more holistic view on inflation and economy The ECB is increasingly shifting focus towards a more holistic view of the euro area economy and inflation, with a strong belief that the closing output gap in light of ongoing expansion and continued employment gains will eventually push underlying inflation pressures higher. In line with this thinking, the so-called super core inflation measure has increasingly featured in recent speeches by ECB members. Super core consists of a sub-index of all HICP items that have been closely correlated with the output gap in the past and could hence provide important signals about turning points in inflation. Source: ECB, Eurostat, Macrobond Financial, Danske Bank The ECB does not publish the series but using the ECB s methodology we have tried to replicate it (see also Euro Area Research ECB inflation gap persists in 2019, 4 December). Both our and the ECB s super core inflation measures indicate an upward trend since 2017. Should this increasing trend continue, it would support the ECB s argumentation of a pickup in underlying inflation pressures, providing it with a good excuse to end the QE programme in 20. Source: ECB, Eurostat, Macrobond Financial, Danske Bank Aila Mihr, Analyst, amih@danskebank.com, +45 45 12 85 35 5
Consensus is growing in the Governing Council that October QE extension was the last one Recent remarks from ECB members have repeatedly hinted at a preference for the October QE extension to be the last one. Yves Mersch: Market would be wrong to expect another QE extension ; CB toolbox not limited to asset purchases. François Villeroy de Galhau: There shouldn t be excessive focus on the net QE purchases. Benoît Cœuré: I hope that asset purchases will end in September The minutes from the October meeting also revealed that several members favoured decoupling the forward guidance on QE from the requirement for a sustained rise in inflation, instead linking it to the overall monetary policy stance, i.e. the combination of new asset purchases, the existing stock of QE assets plus reinvestments and the forward guidance on policy rates. If this view were to become more prominent in the Governing Council over coming months, it would open up the possibility of the ECB ending the QE programme in 20, even without a clear pickup in inflation. Markets are so far still very complacent, pricing in the first ECB 10bp hike not before July 2019. Hence, further hawkish comments in coming months hinting at the possibility the ECB could phase out QE purchases earlier than markets are currently looking/wishing for could be a trigger for a reassessment of current market expectations. 25 20 15 10 5 0 bp ECB dated Eonia swaps (assuming neutral Eonia is 5bp above deposit rate) 0.6 0.6 0.4 0.0-0.2-0.3-0.1 1.5 0.3 0.7 3.7 6.1 8.4 10.8 13.3 16.0.9-5 Dec 17 Mar Jun Sep Dec Feb 19 May 19 Aug 19 Nov 19 22.0 Aila Mihr, Analyst, amih@danskebank.com, +45 45 12 85 35 Source: Danske Bank 6
ECB s exit strategy set to become a theme in 20: QE programme set to end in Q4, with first hike in Q2 19 We expect the ECB to stick to its communicated exit sequence and end QE before hiking rates. We think the ECB will end the QE programme in 20 due to the following. Core inflation staying above 1.0% in 20 and 2019. Binding technical restrictions. The growing size and importance of reinvestments of maturing bonds. Deflation risks have disappeared. Source: ECB, Macrobond Financial, Danske Bank QE redemptions to grow in size in 20 Given rising underlying inflation pressure, we expect the ECB to deliver its first 10bp hike in Q2 19, as, in our view, it will be keen to regain room to manoeuvre for future crises and avoid falling behind the curve. 30 25 20 15 EUR bn 10 5 For more details on the ECB s exit strategy from extraordinary monetary policy measures, see Special Report: The Euro- Scandi exit and what it implies for markets, 30 November. 0 Dec 17 Jan Feb Source: ECB, Danske Bank Mar Apr May Jun Jul Aug PSPP CSPP CBPP ABSPP Sep Oct Nov Aila Mihr, Analyst, amih@danskebank.com, +45 45 12 85 35 7
Four out of six dovish executive board members will end their term by 2019 opening door for a more hawkish ECB in 2019? Sabine Lautenschläger (hawkish) Jan 2022 Cœuré (dovish-neutral) Dec 2019 Vito Constâncio (dovish) May 20 Peter Praet (dovish) May 2019 Draghi (dovish) Oct 2019 Mersch (hawkish-neutral) Dec 2020 2010 2011 2012 2013 2014 2015 2016 2017 20 2019 2020 2021 2022 Source: ECB, Danske Bank Aila Mihr, Analyst, amih@danskebank.com, +45 45 12 85 35 8
Credit: Private-sector purchases to remain sizeable We think QE composition could also factor in the discussions at the December meeting. The October ECB Minutes stated that the purchase volumes under the three private sector purchase programmes would remain sizeable and the private sector programmes would not be adjusted in strict proportion to the overall scaling-down of the APP. 25% 20% 15% 10% 5% Share of net purchases by component 100% 80% 60% 40% 20% In our view, this suggests that the corporate bond and covered bond purchase programmes (CSPP and CBPP3, respectively) share of total net purchases will be increased from January 20. The ABS purchase programme has played only a minor role due to the lack of eligible assets. In our view, CSPP is likely to account for the bulk of private sector purchases, given that the ECB s ownership rate is lower within the corporate market. However, the ECB is also likely to remain active in the covered bond market, particularly in the primary market. Furthermore, purchase flows will also be supported by redemptions, with EUR1.6bn of covered bonds maturing per month on average from January through to end-september 20. 0% CSPP CBPP3 PSPP (right axis) Source: ECB, Danske Bank Indicative ECB ownership rates across QE portfolios 50% 40% 30% 20% 10% 0% 0% Sverre Holbek, Senior Analyst, holb@danskebank.dk, +45 45 14 88 82 CBPP3 Supras PSPP (excl supras) CSPP Source: ECB, Markit, Danske Bank 9
Fixed income: tighter spreads and flatter curves We expect the trend for tighter spreads between core-eu and semi-core/periphery to continue even though the spread between, for example, France and Germany is very tight. We expect the slope of the German curve in the 10-30Y segment to flatten as the ECB is slowly moving towards the exit. Source: Danske Bank, Macrobond Financial Source: Danske Bank, Macrobond Financial Jens Peter Sørensen, Chief Analyst, jenssr@danskebank.dk, +45 45 12 85 17 10
FX: too early for ECB to spur next wave of normalisation pricing (just yet) December 2017: An unchanged policy stance but upward growth/inflation revisions from the ECB should keep EUR/USD afloat and (roughly) within the 1.17-1.20 range near term despite USD rate support. 20: An ECB shift towards a more holistic view on the economy should foster the next wave of ECB normalisation trades in mid-20 EUR/USD eventually towards 1.35 in ECB exit scenario Source: Macrobond Financial, Danske Bank Source: Macrobond Financial, Danske Bank 11
Disclosures This research report has been prepared by Danske Bank A/S ( Danske Bank ). The authors of this research report are Aila Mihr (Analyst), Jens Peter Sørensen (Chief Analyst), Christin Tuxen (Chief Analyst) and Sverre Holbek (Senior Analyst). Analyst certification Each research analyst responsible for the content of this research report certifies that the views expressed in the research report accurately reflect the research analyst s personal view about the financial instruments and issuers covered by the research report. Each responsible research analyst further certifies that no part of the compensation of the research analyst was, is or will be, directly or indirectly, related to the specific recommendations expressed in the research report. Regulation Danske Bank is authorised and subject to regulation by the Danish Financial Supervisory Authority and is subject to the rules and regulation of the relevant regulators in all other jurisdictions where it conducts business. Danske Bank is subject to limited regulation by the Financial Conduct Authority and the Prudential Regulation Authority (UK). Details on the extent of the regulation by the Financial Conduct Authority and the Prudential Regulation Authority are available from Danske Bank on request. The research reports of Danske Bank are prepared in accordance with the recommendations of the Danish Securities Dealers Association. Conflicts of interest Danske Bank has established procedures to prevent conflicts of interest and to ensure the provision of high-quality research based on research objectivity and independence. These procedures are documented in Danske Bank s research policies. Employees within Danske Bank s Research Departments have been instructed that any request that might impair the objectivity and independence of research shall be referred to Research Management and the Compliance Department. Danske Bank s Research Departments are organised independently from and do not report to other business areas within Danske Bank. Research analysts are remunerated in part based on the overall profitability of Danske Bank, which includes investment banking revenues, but do not receive bonuses or other remuneration linked to specific corporate finance or debt capital transactions. Financial models and/or methodology used in this research report Calculations and presentations in this research report are based on standard econometric tools and methodology as well as publicly available statistics for each individual security, issuer and/or country. Documentation can be obtained from the authors on request. Risk warning Major risks connected with recommendations or opinions in this research report, including a sensitivity analysis of relevant assumptions, are stated throughout the text. Expected updates Ad hoc. Date of first publication See the front page of this research report for the date of first publication. 12
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