ECB lowers growth outlook, while US activity rebounds

March ECB meeting - When “tiny steps” are not that small:

At its March meeting, the European Central Bank (ECB) made sizeable downward revisions to growth and inflation. 2019 GDP has been revised down 0.6 percentage points to 1.1% year-on-year (yoy) due to persistent adverse factors and weak underlying cyclical momentum, just a touch above our 1% yoy forecast. This weaker growth outlook implies that the pass-through from higher wages to higher prices will take more time: the inflation profile has been revised down across the horizon, with the harmonised index of consumer prices (HICP) now expected at 1.2% in 2019, down 0.4pp from previous estimates, and only at 1.6% at the end of ECB forecast horizon in 2021. Given the weaker environment, the ECB stepped up its monetary policy decisions: it changed its forward guidance on interest rates, saying that key rates will remain  at their present level at least through the end of 2019, instead of September 2019.  

We are thus switching our baseline, and believe the ECB will be unable to hike this year and next (a risk we flagged in our paper Waiting for Godot- Waiting for depo). In addition to the change in forward guidance, the ECB announced a new round of targeted long-term refinancing operations (TLTRO). The new series of quarterly TLTROs with a two-year maturity will start in September 2019 and end in  March 2021. Under TLTRO-III, counterparties will be entitled to borrow up to 30% of the stock of eligible loans as at 28 February 2019 at a rate indexed to the interest rate on the main refinancing operations over the life of each operation. There will be an incentive mechanism but no details have yet been released. Finally, weekly lending operations will continue to be conducted through a fixed-rate, full allotment procedure at least until 21 March. ECB President Mario Draghi, when describing the Bank’s monetary policy decisions, explained that when in a dark room, you do not stay immobile, neither do you make big moves. Instead, you opt for tiny steps. In our view, the monetary policy decisions taken at the March meeting where not tiny.

A word on the data: German industrial production disappointed, falling by 0.8% month on month, primarily on car production weakness. The latter fell 9.2% mom, at odds with the encouraging signals sent by German factory orders and suggesting that the automotive sector will likely continue to weigh on industrial activity. This is consistent with our forecast for a moderate rebound in German GDP growth to 0.2% qoq in the first quarter of 2019.

Most measures of economic activity posted strong rebounds in the US last week.

ISM’s non-manufacturing purchasing managers’ index (PMI) rose back towards the top of its post-GFC range; new home sales and housing starts have posted solid gains over the past two months; productivity growth accelerated and consumer confidence reached a 2001 high. The headline gain in non-farm payrolls was the exception, falling to a 17-month low of 20,000. However, headline unemployment fell to 3.8%, while the broader U6 measure, which takes account of unemployed people, underemployed people, and so-called marginally attached workers, fell to 7.6% At the same time wage growth reached a cyclical-high of 3.4%. January’s retail sales are also expected to rebound from December’s shock drop, while CPI inflation, durable goods orders and the Empire State manufacturing survey will all be watched to confirm an ongoing outlook for solid domestic expansion amid signs of soft global activity.

Trade talks continue, with progress slow and few signs yet of when the expected summit between US President Donald Trump and Chinese President, Xi Jinping will be held. Elsewhere in Washington, the Senate looks close to endorsing a House measure to overturn President Trump’s emergency funding for a border wall between the US and Mexico – something that would then require a Presidential veto to overturn. The House also looks set to pass a motion to make the impending Mueller report into possible Russian interference in the 2016 presidential election public. 

The UK’s Brexit process enters its most significant week yet.

UK Prime Minister Theresa May is still negotiating with the European Union to deliver further reassurances over the contentious Ireland border backstop arrangement. The degree of success will help determine the first of three votes this week, on Tuesday evening. Tuesday’s vote will attempt to overturn the historic 230 vote loss following the first attempt to endorse the negotiated deal. While a second vote can only deliver improvement, we still expect this to fail. This would lead to the next vote on Wednesday: asking Parliament to endorse a “no deal” exit. Parliament has already rejected the possibility of a “no deal” exit in the Spelman amendment in January and we expect this to be repeated on Wednesday. This would leave a vote on a proposal to request an extension of Article 50 on Thursday, which we expect Parliament to approve.

Wednesday also sees the Chancellor of the Exchequer’s Spring Statement. Chancellor Philip Hammond has been keen to make this a non-fiscal event, something that ongoing Brexit uncertainty would underscore. However, a number of spending commitments that are contingent on a deal being agreed can be expected in what is otherwise likely to be a benign update of the short-term outlook for the public finances. Finally, Wednesday also sees January’s GDP estimate. We expect GDP to continue at a subdued 0.2% in the first quarter, with Brexit uncertainty continuing to depress activity. 

The tone from China’s National People’s Congress (NPC) suggests more cautious stimulus for a more tepid recovery.

A lower growth target – “6-6.5%” from “around 6.5%” in the last two years – suggests Beijing understands the prevailing economic challenges and is no longer willing to sacrifice growth quality for speed as much as it has done in the past. However, leaving the economy high and dry amid stiffened economic headwinds is also unpalatable given the potentially severe macroeconomic consequences. Hence, what was unveiled today by Premier Li Keqiang represents, in our view, an effort to strike a fine balance between near-term growth stability and long-term economic sustainability. This balance is partly reflected in the choice of policy tools – i.e. fiscal policy, particularly tax cuts – for short-term stimulus, but also in Beijing’s cautiousness when it comes to opening the “liquidity flood gate” or significantly relaxing housing market policies. We think these measures will be sufficient to put a halt to the current economic slowdown, but not enough to generate the vigorous growth rebounds seen in past cycles.

We maintain our below-consensus call of 6.1% growth for 2019. On the flipside, the more sustainable stimulus, coupled with accelerated reforms, should improve the quality of growth, helping to extend the positive momentum seen in Chinese markets year to date. Apart from the NPC meeting, Chinese credit numbers were released over the weekend. Total social financing dropped to RMB703bn and total credit growth moderated to 10.1%, unwinding from January’s strength. The more-than-expected decline in the credit numbers was partly the result of weaker acceptance bill and bond issuances, but also partly due to seasonality. However, a high number for combined data from January and February implies that monetary policy is still hitting the ground, and the People’s Bank of China reiterated at the press conference the importance of prudent monetary policy going forward.

External weakness continues.

Both exports and imports continued to see softening. Chinese exports dropped to -21% yoy after rebounding in January, partly from the weakening external economic momentum. Most of this downturn was due to Lunar New Year distortions as exporters tend to front-load shipments prior to the holidays. Korea and Taiwan also saw a broad-based decline in the February export numbers. Exports for January and February combined, in general underperformed market expectations, indicating that external demand continued to weaken at the start of the year.

Similarly, imports for all three countries slumped on February, in particular Korea and Taiwan’s import data, which registered the lowest since 2016, reflecting the weak domestic demand picture. This is consistent with the Markit PMIs with many headline numbers staying below the waterline and new export orders PMIs continuing to contract. Going forward, it is necessary to keep monitoring these early indicators for any possible signs of bottoming. On the inflation front, pressure remains benign on the back of easing food and agricultural prices. Though oil prices have recovered somewhat recently, we believe CPIs will remain in the lower range of the target throughout 2019. Considering the near-term weakness in external and domestic conditions, muted inflationary pressure will cause many central banks to maintain a cautious stance in the near-term, and possibly lean towards a dovish bias.

The Bank of Japan holds its Monetary Policy Meeting on March 14-15 and we believe the status quo should be maintained

The short-term policy rate target (-0.1%) and 10-year JGB yield target of 0% (with a band of +/- 20 bp) should remain unchanged, while the ETF programme and the long-term decrease in net Japanese government bond purchases should continue. Discussions will also focus on the activity assessment with export and production data in the spotlight.

These negative figures have probably triggered a recession in Japan at the end of 2018 and the government could retroactively announce it. Even if we expect a rebound in February data, especially because a large part of the fall has been explained by a calendar effect (Lunar New Year holidays in China), the latest news is not very optimistic. If February’s data contains a negative surprise, the BoJ could react further in the coming months

Upcoming events:
Euro Area: EU19 Industrial production and Spanish final HICP (Wednesday), German and French final HICP and German CPI (Thursday), EU19 final CPI and Italian HICP (Friday)
US: NFIB small business optimism, CPI and Construction spending (Tuesday), PPI and Durable goods orders (Wednesday), Jobless claims and New home sales (Thursday), Empire State manufacturing survey, Industrial production , Michigan consumer sentiment JOLTs and long-term investment flows (Friday)
UK: Industrial Production, Manufacturing output, Index of services, Construction output Total trade balance, Trade in goods and Meaningful Vote (Tuesday), Spring Statement and ‘No-Deal’ Vote, (Wednesday), RICS Housing Survey and Article 50 extension vote (Thursday)
Japan: Private ‘core’ machinery orders (Tuesday), BoJ announcement (Friday)
China: Industrial Production, Retail sales, Fixed asset investment and Unemployment (Thursday), New home prices (Friday)

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