European and Global Interest Rates
Last week, the ECB had tailor-made messages for its two main audiences: for the German-speaking audience a hawkish one and for financial markets a dovish one. Since the US elections and the subsequent increase in bond yields, some market observers have started to speculate about a possible shift in the ECB’s monetary stance. Could the current Trumpflation also lead to early tapering in Frankfurt? In our view, any change in the ECB’s monetary policy as a reaction to the US elections looks extremely unlikely. It is simply too early for the ECB to incorporate any changes in US policies into its own staff projections. As a consequence, the weaker euro and slightly higher oil prices since the September projections should lead to the only relevant shifts in the ECB staff’s economic forecasts. In our view, the most likely outcome should be a slight upward revision of the inflation forecasts. It looks plausible that there could be repetition of earlier meetings at which the Governing Council took a more cautious stance on the economy than reflected in the staff projections. In terms of Trumpflation, the recent increase in bond yields in the Eurozone should be a welcome development in the eyes of the ECB. A slight steepening of the yield curve could bring some tiny relief for the banking industry and would help ECB President Draghi counter Bundesbank attempts to reduce QE. At the same time, higher bond yields should also caution the ECB to prematurely hint at any tapering, as it could trigger an unwarranted wider sell-off. With or without the US elections, the situation for the ECB has not really changed. Inflation is not high enough and the economy is not strong enough to seriously justify a reduction in QE. At the same time, inflation is not low enough and the economy is not weak enough to really justify stepping up QE. Consequently, the ECB will be stuck in the dilemma of having to balance market expectations and inner peace. In this context, last week’s comments by ECB President Mario Draghi and ECB Executive Board member Yves Mersch made sense. While Mersch told a German audience in German that the ECB’s non-standard measures should be reversed as soon as possible, Draghi told an international audience that “we do not see a consistent strengthening of underlying price dynamics…So even if there are many encouraging trends in the euro area economy, the recovery remains highly reliant on a constellation of financing conditions that, in turn, depend on continued monetary support”. All of this makes us stick to our earlier view that the ECB will extend its current QE programme in December by 3 to 6 months, without altering the volume of the monthly purchases.