Ahead Of The ECB

Notes From The Last Meeting

ECB paused as expected, leaving main refinancing rate unchanged at 0.0% and deposit rate at -0.4%. President Mario Draghi left the door open for extension of the stimulus program if needed and commented that “UK should remain in the European Union, because the European Union would benefit from its permanence”, joining BOE in highlighting downside risks of Brexit. June’s macroeconomic projection foresee real GDP to increase 1.6% this year and 1.7% in the next two years, with this year’s forecast revised slightly higher from March forecast. CPI was also revised higher for this year to 0.2% in 2016 (previous 0.1%), but unchanged at 1.3% in 2017 and 1.6% in 2018.

Data & Developments

Since the ECB last met on June 2nd the European, and indeed global, financial landscape has seen a dramatic shift with the UK having voted to leave the EU.  The aggressive market reaction, which emphasised just how unexpected the decision was, has since given way to a wave of growing expectations for further global central bank easing.

Data flow since the last meeting has been skewed to the upside with the key takeaway being a small uptick in inflation with the headline reading having moved out of negative territory.

Positive

EZ GDP 1Q 1.7% vs 1.5% exp
EZ CPI May -0.1% vs -0.1% and 0.8 vs 0.8 vs
EZ Manufacturing PMI Jun
EZ CPI Jun 0.1% vs 0  0.9% vs 0.8% core
Unemployment rate EZ 10.1% VS 10.2% prior

Negative

EZ Services & Composite PMIs Jun
EZ Industrial Production May 0.5% 1.3%
EZ Retail Sales 1.6% vs 1.7% May

euinflation

During this period, we’ve also heard from a raft of ECB members.  ECB’s Constancio reiterated the bank’s capacity to deal with the Brexit fallout noting that “We still have instruments in our toolkit” even if it is “true that we have been using a lot of those”.  Mr. Nowotny, speaking just says after the Brexit results, said there had been an “overreaction on banks” and “we now see a period of cooler heads”.  Mr. Hansson noted that the Brexit decision could disrupt the bank’s efforts to boost the EuroZone economy as “it’s one more factor creating uncertainty”. Mr. Hansson also stated that the bank “continue to monitor the trends on financial markets and if there is a need to provide additional liquidity.” Regarding the scale and effectiveness of current stimulus Mr. Hansson said “We have more…It’s just that much tougher in the current environment to make the last steps, visible changes in the headline inflation. We just need some faith and to take a bit more time.”

Expectations Ahead of The Meeting

Whilst markets expect that the bank will remain in wait and see mode, in line with the other G10 central banks, to allow for the assessment of further post-Brexit data before committing to a course of action, investors are expecting the ECB to outline their intention to roll out further measures in August/September. The investor reaction to Brexit has seen focus shifting on to the weaknesses within the region such as the debt-related challenges of the Italian banking sector and broader issues such as political and geopolitical instability.

Some analysts expect that the ECB will respond immediately in the wake of Brexit however there a few reasons which seem to suggest this course is unlikely. Firstly, the BOE themselves have yet to respond with any policy adjustment, secondly we have seen a fairly orderly response from periphery bond markets and finally the ECB are still waiting to assess how the launch of CSPP and TLTRO2 programmes have fared in terms of stimulating economic activity over the last few weeks.

Market response to Brexit, beyond the initial shock reaction, has so far been muted. The biggest destabilisation that has occurred is to investor confidence in the region and investor are now starting focus on some of the EuroZone underlying weak points which may cause trouble in a post-Brexit world such as the debt challenges of the Italian banking sector and wider issues such as Political and Geopolitical instability in the region.

Recent climbs in energy prices have stimulated a small increase in inflation and look set to prompt further increases but core inflationary pressures and inflation expectations remain heavily subdued.

Draghi to highlight downside risks, signal further easing

Given the broader outlook for the EuroZone it is likely that we see the ECB Chief highlighting the risks to both the growth and inflations forecasts and the likely necessity of further easing in the coming months.

Overall there is a small risk of EUR upside on the back of this month’s meeting, similar to the GBP reaction we saw in response to the BOE meeting earlier this month. EUR positioning remains skewed to the downside and if Draghi & co. fail to provide a clear catalyst for continued downside we could see a squeeze higher.