Dovish Expectations From ECB
ECB DOVISH RHETORIC EXPECTED
The most recent Eurozone data have not been entirely encouraging. The services PMI, in particular, was surprisingly weak in August (even though it was revised up slightly to 50.5 in the final estimate), suggesting that renewed increases in Covid cases could weigh on activity – see chart 1. Eurozone retail sales fell 1.3% in July, while annual CPI inflation dropped into negative territory in August to -0.2%y/y, according to the flash estimate. Despite all that, the euro briefly topped $1.20 this week, the first time for more than two years, before the ECB’s Chief Economist Lane warning that “the euro-dollar rate does matter”. The ECB decides on policy next week (Thu). In June, it had already increased the envelope of its Pandemic Emergency Purchase Programme (PEPP) to €1,350bn in June which, based on the current pace of purchases, should last well into next year. As such, policy settings are likely to remain unchanged next week, and the focus instead will be on the ECB’s new economic projections and communication. In June, the ECB predicted Eurozone GDP growth to fall 8.7% this year, before rising by 5.2% in 2021, while headline CPI inflation was forecast to still be below target in 2022 at 1.4%. There may be some tweaks to the forecasts, given the stronger euro but also higher oil prices, but particular attention may perhaps be reserved for the core CPI projection (in June it was expected to be at only 0.9% in 2022). Given softening in some of the recent high-frequency economic indicators, the rhetoric from the ECB is expected to be dovish, emphasising downside risks to the outlook and its readiness to increase stimulus measures further, possibly later this year.
RISK SENTIMENT TURNED LOWER Global equity markets have been on an extraordinary uptrend since March, but there was sharp sell-off from Thursday, especially in technology stocks, an indication perhaps of an overextended rally in the eyes of some investors. Central banks continued to sound dovish, recapping the need to maintain accommodative policy to support the economic recovery. This week, Bank of England MPC members reiterated that there was plenty of room to further increase stimulus, principally with more QE but also keeping open the option of negative interest rates. Some ECB officials were reported as being increasingly concerned about the euro’s recent rise. The Fed, meanwhile, has already shifted to average inflation targeting, which allows for inflation overshoots to make up for past undershoots. Yet, despite that, US 10-year Treasury yields remain flaccid, falling back below 0.70%. Perhaps markets are concerned that monetary policy alone will not be able to drag inflation towards the target and that additional fiscal stimulus will be needed. Indeed, Chicago Fed President Evans warned that partisan politics and a lack of fiscal action present a “very significant downside risk to the economy”. Some US data seem to show already that the recovery may be slowing (although not stalling).
UK JULY GDP TO SIGNAL STRONG Q3 REBOUND
We expect UK monthly GDP figures (Fri) to show another very strong increase of 8.0% in July, following rises of 8.7% in June and 2.4% in May. That would leave economic output about 10% below February levels, compared with about 25% down in April – see chart 2. The economy is set for a strong rebound in Q3, having contracted by more than 20% in Q2. Other releases include August BRC retail sales (Tue) and the RICS housing survey. The outlook beyond Q3 is less certain. A number of potential risks lie ahead including the impact of the end of the furlough scheme on unemployment, renewed increases in coronavirus cases and uncertainties surrounding UK-EU trading arrangements from the start of next year after the end of the transition period (assuming it is not extended). A seventh round of formal UK-EU trade talks take place in London next week, with negotiations reportedly deadlocked, especially over the issue of state aid provisions.
US FISCAL IMPASSE
It is a quieter, holiday-shortened week in the US. There will be no Fed speakers ahead of the FOMC meeting in the following week. The main data releases are weekly jobless claims (Thu) and CPI inflation (Fri). Initial claims for the latest week fell by more than expected to 881k, although a new seasonal adjustment method made comparisons to past data more difficult. For August CPI, we forecast a rise in the headline measure to 1.1%y/y from 1.0%, but a fall in the core rate to 1.5%y/y from 1.6%. Congress starts to return next week after Labor Day, with little sign yet that Democrats and Republicans are near an agreement on additional fiscal stimulus.
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