All eyes on the ECB

Chris Scicluna
Emily Nicol

Mixed messages from the latest data – with a weak ADP jobs report contrasting an improved non-manufacturing ISM survey – left investors none the wiser about the strength of the US economy yesterday. But while USTs therefore struggled for direction, US equities made further gains, with the S&P500 closing up 0.8% on the day. However, futures markets weakened later on, as President Trump stated that progress in talks between US and Mexican officials was “not nearly enough” to avoid the imposition on Monday of new 5% tariffs on imports from South of the border. And the more uneasy mood carried over to the major Asian markets today, with most in the red. With little in the way of macroeconomic news from the region, Japan’s Topix closed down 0.3% while China’s CSI300 fell 0.9%. In the bond markets, following yesterday’s notable gains on the back of BoJ easing talk, JGBs were only a touch weaker. But ACGBs were again slightly stronger as the latest Australian trade report fell slightly short of expectations with imports outpacing exports (detail below).

In Europe, this morning has already brought new data on German factory orders, which remained disappointingly subdued after recent sharp declines (see more on this below too). And all eyes later on will be on the ECB where, among other things, the pricing of the forthcoming TLTRO-III operations will be announced, with banks (and policymakers) in Italy and Spain in particular hoping for a generously low interest rate to be applied. While the central bank’s updated economic forecasts might well be little changed from three months ago, the Governing Council’s guidance on future policy will be watched closely not least given the recent slide in market-based measures of inflation expectations close to record lows.

Euro area:
All eyes today will be on the conclusion of the ECB’s latest policy meeting. The meeting will be the first to be conducted under the ECB’s new Chief Economist Philip Lane, who replaced Peter Praet at the start of the month. Among other things, the meeting will be watched closely for the updated staff economic forecasts and additional details for the pricing of the forthcoming TLTRO-III liquidity operations, due to start in September.

When the ECB initially unveiled the new TLTRO-III programme in March, it also announced significant downward revisions to its growth forecasts. Subsequently, however, Q1 GDP exceeded expectations with the 0.4%Q/Q growth rate twice the ECB’s central projection. So, this time around we might well see a modest upward revision made to its full-year growth forecast of 1.1% in 2019. But despite some improved surveys, as suggested by today’s final May PMIs underlying economic momentum isn’t necessarily materially stronger than it was three months ago. So, there would seem little case for the ECB’s (overoptimistic) projections for 2020 and 2021 (1.6% and 1.5% respectively) to be revised up significantly, and the Governing Council will likely judge that the risks to the outlook are still skewed to the downside.

Following significant volatility in prices around the Easter holiday period, the inflation outlook seems unlikely to be judged by the ECB to be substantially different from March’s assessment too, with headline and core CPI forecast to increase 1.2%Y/Y in 2019, rising to just 1.6%Y/Y in 2021. So, the ECB might well see no need to change its forward guidance at this meeting, and on balance our expectation is that it will merely reiterate that interest rates are still expected to remain unchanged “at least through the end of 2019”. However, given the recent decline in market-based measures of inflation expectations close to record lows, Draghi will no doubt underscore the ECB’s readiness to adjust all instruments, as appropriate, to help push inflation back to target. Of course, the ECB’s willingness to take such further action – and increased expectations that it will indeed be forced eventually to do so – helped to push Bund yields down to record lows in recent days.

Among other factors, the ECB’s assessment of the economic outlook will help determine the pricing of its TLTRO-III operations, which were announced primarily to prevent a tightening of financial conditions that would have occurred as roughly €740bn of remaining loans issued under the previous TLTRO-II programme matured. With the inflation outlook underwhelming, we see a strong case for the ECB to announce generous pricing on its forthcoming TLTRO-III loans, no less favourable than those attached to the TLTROs-II. Under that programme, the interest rate applied to the amount borrowed was initially linked to the refi rate prevailing at the time of take-up, but could fall to as low as the deposit rate (-0.40%) for banks whose net new lending exceeded a benchmark. And with the maturity of the new TLTRO-III loans to be just two years, only half that offered under the previous framework, it would seem unhelpful to have other conditions also significantly less generous this time, not least as any adverse market reaction could further negate the intended extra policy accommodation provided.

Of course, in line with its commitment made at the April policy meeting, the Governing Council will also assess whether to take any further action to mitigate the possible adverse side-effects of negative interest rates on bank intermediation. However, we do not see a strong case for action in this respect (e.g. via the introduction of a tiered interest rate framework), and certainly do not anticipate new measures related to the banking sector, beyond the TLTROs-III, to be announced today.

Data-wise, ahead of tomorrow’s German IP report for April, this morning brought the release of factory orders figures for that month. These showed only very modest growth at the start of the second quarter, with total orders up 0.3%M/M in April, following an upwardly revised increase (0.8%M/M) in March. Given the considerable weakness at the start of the year, this still left orders down more than 5%Y/Y. When excluding major orders, the improvement in April was at face value more impressive, with orders up more than 2%M/M, the largest increase since November 2017. But this followed declines of a similar magnitude in the previous three months, to leave the level in April broadly in line with the Q1 average, which itself was the weakest since Q416.

Within the detail, the pickup in April was driven by overseas orders with those (excluding major orders) from the euro area up more than 5%M/M (largely offsetting the decline in March). Other foreign orders increased for the second successive month and by almost 3%M/M. But domestic orders remained weak, falling for the third month out of the past four to their lowest level since November 2014, weighed particularly by orders of intermediate goods (down more than 2%M/M) while capital goods orders remained sluggish following a steep drop in March.

So, overall, despite the more positive headline figure, today’s data reinforced the downbeat messages from recent manufacturing surveys which have signalled ongoing weakness in orders and production alike in Q2. Indeed, today’s reports also showed that manufacturing turnover declined 0.6%M/M in April, following growth of just 0.1%M/M previously. So, having risen in the previous two months, production in the sector seems likely to have declined in April, with the consensus expectation for tomorrow’s release to show a drop of ½%M/M, fully reversing the increase in March.

Meanwhile, ahead of the ECB’s announcement we’ll see the release of the final reading of euro area Q1 GDP. While growth is expected to align with previous estimates at 0.4%Q/Q, this release will bring the first official expenditure breakdown in Q1, which is expected to show that the acceleration at the start of the year was driven principally by domestic demand with a more modest positive contribution from net trade. Euro area employment figures are also expected to confirm growth of 0.3%Q/Q in Q1.

In the markets, France and Spain will auction bonds with various maturities.

In the US, today will bring April’s full trade report, along with revised productivity and labour costs figures for Q1. Ahead of Friday’s payrolls figures we will also see the release of Challenger job cuts figures for May and weekly jobless claims numbers. In terms of the trade report, we already know that the goods trade deficit increased $0.2 billion in April, with a negative revision of $0.5bn also made to March. And this should feed through to increase the total trade deficit commensurately from the current estimate of $50.0bn for March. Speeches by FOMC members Williams and Kaplan will also attract attention today.

After yesterday’s GDP release showed that net exports gave welcome support to economic growth for the first quarter in three, April’s trade report today pointed to a negligible contribution at the start of Q2. The trade surplus came in a touch weaker than expected, albeit little changed on the month at a near-record high of AUD4.9bn, with a 2.5% rise in the value of exports offset by a 2.8%M/M increase in the value of imports. Within the detail, the increase in exports was underpinned by a near-3% rise in goods exports as shipments of metal ores increased 16%M/M. Meanwhile, on the side of the ledger, goods imports were up almost 4%M/M, with solid increases in consumption, capital and intermediate goods alike, but services imports fell for the third month out of the past four.



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