ECB STARTS TO APPLY THE BRAKES
During its 14 June meeting, Europe’s central bank indicated that its asset purchase programme would finish at the end of the year. In the final three months of 2018, monthly purchase volumes will be halved from €30 billion to €15 billion before coming to a halt. Then, and for an extended period, the ECB will focus on reinvesting maturing securities.
The ECB also indicated it would seek to keep its benchmark interest rates at their current levels until the summer of 2019 (deposit rate at -0.40%, refinancing rate at 0.00%, and the marginal lending facility at +0.25%), on the understanding that the economic picture remains consistent with expectations.
The ECB does not see this year’s softer start as threatening the eurozone’s economic upturn, instead believing some of the softness is due to temporary factors (bad weather, strike action in certain countries) and that growth should remain buoyant.
The unemployment rate continues to fall (8.5% in April), signs of higher wages are starting to show, and the surveys remain consistent with growth of around 2%, which is higher than current eurozone potential. Reassuringly, June’s rebound in the composite PMI (54.8 versus 54.1 for the preliminary reading) puts an end to four monthly falls in a row.
The ECB’s balance sheet will peak at just over 40% of GDP. The US Federal Reserve equivalent was 25% at the end of 2014. The ECB’s statements indicate that its endgame strategy will be very similar to that of the Federal.
Reserve, namely a process that starts with a halt in asset purchases, followed by higher rates and doubtless the start of balance sheet shrinkage once rates have risen several times.
Regarding Italy, ECB chief Mario Draghi played down the recent negative impact on sovereign spreads by calling events a local episode and nothing like the 2011-2012 period, neither in size nor in terms of member State contagion. He emphasised that safeguards had been put in place within the eurozone to avoid redenomination risk.
However, the political situation in Italy remains unstable and the sustainability of the nation’s debt could be called into question if the government even partially implements its stated programme.
SOLID GROWTH
The BEA’s second estimate of US first-quarter growth was revised marginally down (-0.1 to +2.2% on an annualised quarterly basis, versus +2.9% for the previous quarter). However, the breakdown picture is healthier with growth driven more by domestic final demand and less by inventory adjustments.
Activity indicators are pointing to faster second-quarter US growth. April’s consumption spending is strong at +0.4% and May’s retail sales are a healthy +0.5%, paving the way for another strong quarter and confirming the view that the soft start to 2018 was nothing more than a blip.
That said, consumer spending can be expected to return to more normal levels, especially as the rapid fall in saving rates seen in the past two months (-0.4 points to 2.8%) is not easily sustainable. The overall fundamental picture is buoyant.
May’s employment report confirmed the labour market’s strength with firm momentum in terms of job creations (+218,000 private sector), and steadily rising hourly earnings (+2.7% year-on-year), both of which should underpin disposable income levels. The unemployment rate has dipped beneath the low reached in 2000 to stand at 3.8%.
Inflation remains moderate, albeit steadily accelerating. At an annual +2.2% in May, it is rising slightly faster than the Fed’s medium-term target of 2%.
Against this backdrop, the Fed chose the 12–13 June meeting to announce another 25 bps benchmark rate hike, taking its target range to 1.75%-2.00%. Investors had been fully expecting the Fed increase and the focus was on the FOMC’s updated rate forecasts.
The median forecast is for two more 25 bps rate increases this year, bringing the total number of hikes to four for 2018, compared with the three that had been expected.
Forecasts further out are unchanged: three rate increases in 2019 plus one more in 2020. The futures markets have priced in the current 2018 Fed scenario but are expecting just two rate hikes for 2019 and none at all for 2020.
SIGNS OF SLOWDOWN
China’s May data releases clearly highlight a slowdown in activity in the second-quarter following three quarters of stable growth.
Industrial production dipped slightly (+6.8% year-on-year versus 7.0% previously) but remained at a similar growth rate to the first quarter. The slippage in retail sales was marked (+8.5% year-on-year versus +9.4% previously) although temporary distortion effects cannot be ruled out.
The Chinese statistics office signalled certain holiday calendar effects and, following the government’s announcement of a drop in import taxes as of 1 July 2018 (from 25% to 15%), consumers may have delayed car purchases.
Investment spending was the darkest cloud on the growth horizon (+3.9% year-on-year, versus +6.1% previously), and especially infrastructure investment (-1.1% year-on-year, versus +6.4% previously). The fall-off comes following a several-month slowdown in lending as the Chinese authorities take advantage of stable economic conditions to implement measures aimed at deleveraging the financial sector, local government, and state-owned companies.
Bank lending has remained more or less stable year to date (+11.9% year-on-year in May versus +12.3% in 2017) but non-bank lending has fallen sharply and the downtrend steepened further in May (+11.2% year-on-year in May versus +14.9% in 2017).
Tighter lending conditions are starting to affect the real economy and in June, to stave off a too sharp a slowdown, the central bank further reduced the reserve requirements for some banks (-0.5% to 15.50%), in addition to the 100 bps drop announced in April.
The central bank’s move is all the more relevant given the risk for growth posed by possible US protectionist measures. As things stand, the macroeconomic impact of the announced measures (a 25% increase in customs duties on $50 billion worth of Chinese exports) should be relatively small (about 0.1% of GDP). However, if Donald Trump follows through on his threat to raise taxes on $200 billion worth of additional exports, the impact could be more pronounced (between 0.3 and 0.5 % of GDP, according to various estimates).
The opinion expressed above is dated 27 june 2018 and is liable to change.
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