20 April 2018
ECB preview: A general repetition no one really needs

Thursday's ECB meeting will again be one of those most of their officials would rather skip if they could. It should only serve as the prelude to the first QE showdown in June

When the ECB gets together this week, the Eurozone’s central bankers will look at an economy which is currently showing signs of a slowdown and very little evidence that the latest inflation projections are more than just wishful thinking. In fact, the first two months of the year were two months to forget. While the weakening of several confidence indicators could still be filed away as a leveling off from record-high levels, the slide in hard data is more worrisome. It would already need very strong March readings to avoid a disappointing first quarter

The first two months of the year were two months to forget

Still, despite this short-term weakening, it is far too early for the ECB to sound the alarm bells. The optimistic tone of recent months should continue albeit with somewhat more emphasis on downside risks and uncertainty.

As for inflation, there is very little evidence that the ongoing divide between wish and reality will change any time soon. While the ECB remains confident that inflation should pick up, hard data are telling a different story. March inflation only accelerated due to seasonal effects and core inflation remained unchanged at extremely low levels. Also, there seems to be very little price pressure in the production pipeline as producer price inflation has come down significantly from its early 2017 highs. If it was not for traditional cyclical and survey indicators, which still point to an acceleration in headline inflation, there would be very few arguments supporting the ECB’s own projections of headline inflation at 1.7% in 2020.

EUR/CHF at 1.20: Thank Trump

This week EUR/CHF traded at 1.20 – the level of the currency floor which the Swiss National Bank (SNB) abandoned so suddenly in January 2015. We think three factors have played a role here, the largest of which has been fresh sanctions on Russia

Back where it belongs

It’s taken a while – just over three years in fact – but EUR/CHF has finally made it back to the 1.20 level. 1.20 was the SNB’s currency floor up until January 2015, at which point the prospect of ECB quantitative easing and further EUR weakness prompted the SNB to wave the white flag. We think three factors have been driving EUR/CHF strength over recent weeks.

Where next for central banks?

Everything you need to know about central bank policy around the world

Federal Reserve: Tightening on track

There has been a slight sense of loss of momentum in 1Q18, partly weather-related and partly sentiment driven due to protectionist concerns, but on balance we remain upbeat on the US economy’s prospects. Domestic demand is strong, supported by a firm jobs market, rising house prices and an expansionary fiscal policy driven primarily by significant tax cuts. At the same time, the US dollar’s depreciation means exporters are in a competitive position to benefit from the upturn in the global economy.

Meanwhile, consumer price inflation is broadly in line with the Federal Reserve’s 2% target. Given the tight labour market, we find it easy to envisage wage growth rising towards 3.5%YoY later this year. With energy prices and import prices picking up again there is the possibility headline CPI rises towards 3%.

In this environment of robust growth and rising inflation, we forecast the Fed raising rates three more times this year with a further two, possibly three likely for 2019, especially if President Trump makes progress on his infrastructure spending plan. This would take the Fed funds rate up to around 3%.

Four things that matter for the Bank of England as Carney goes cautious

A May rate hike still looks more likely than an August move, but Mark Carney's cautious comments sent a clear warning to those anticipating two or more rate hikes from the Bank of England this year

The 'unreliable boyfriend' is back, or so it seems

Having more-or-less fully priced in a May rate hike, markets have received quite a shock following comments from Bank of England (BoE) Governor Mark Carney that appear to cast doubt over a move at the next meeting. This is all the more surprising given BoE rhetoric so far this year, most of which had suggested policymakers were looking to guide markets towards a May rate rise, following better wage numbers and recent Brexit progress.

So what do we make of all of this? Well for now, we still narrowly think the Bank will hike rates next month, although this has become much more of a 50:50 call. Amidst bad weather, consumer caution and a sharper-than-expected fall in core inflation, it’s entirely possible that policymakers may be looking to buy some time to see how things play out, before considering a rate rise at August’s meeting.

But either way, Carney's comments will send a clear message to markets. The debate on where policy should go next is still far from clear-cut, and this means that any thoughts of two-or-more rate hikes this year still look premature.

Here are four things that will be feeding into the Bank’s thought process.

US: Are we heading to recession?

The US yield curve keeps getting flatter with growing concern it could turn negative. Such a development preceeded all nine recessions since 1955. How worried should we be?

Yield curves and the economic cycle

The US yield curve is currently the flattest it has been for a decade. With the Fed looking set to hike rates another three times this year a growing number of voices are warning we could soon see the yield curve actually invert, meaning it is cheaper for the government to borrow over ten years that it is over 2 years. This is a huge story. When the yield curve has inverted previously it’s been an early warning signal of impending doom - the US has typically fallen into recession within 2 years.

Shrinking oil inventories mean higher prices

ICE Brent broke back above US$70/bbl last week due to geopolitical risks along with some fundamentally bullish developments in the market. We are finding it increasingly difficult to justify our current price forecasts, and therefore have revised them higher

Geopolitical risk in the Middle East

 “Russia vows to shoot down any and all missiles fired at Syria. Get ready Russia, because they will be coming, nice and new and “smart!” You shouldn’t be partners with a Gas Killing Animal who kills his people and enjoys it!”

Those were the words that Trump wrote on Twitter, following allegations that Syria used chemical weapons on its citizens. This was followed by US, UK and French airstrikes on suspected facilities in Syria over the weekend. However, the short duration of the campaign and little retaliation from Russia as of yet, have reduced concerns over the conflict potentially spilling over to the oil market.

Reading time around 6 minutes

In Case You Missed It: The unreliable boyfriend returns

Governor Mark Carney throws a Bank of England May hike into question and the Swiss franc is safe no more. Plus, we try to to get into the heads of global central bankers, figure out what the flattening yield curve means for the US economy, preview an ECB meeting that nobody really needs and revise our oil price forecast 

In this bundle