We now see the ECB announcing a broader stimulus in January, which will include government bond purchases and could eventually exceed a trillion euro. This reflects that the TLTROs saw a low take-up and will unlikely provide the stimulus that the ECB had hoped.
In addition, the inflation outlook has deteriorated over recent months, for a large part due to the slide in oil prices
Nick Kounis Head of Macro Research
In addition, the inflation outlook has deteriorated over recent months, for a large part due to the slide in oil prices. Recent data have been encouraging, signaling the global economy will pick up. However, developments in Greece and Russia also emphasised the risks. Meanwhile, the Fed may signal that rate hikes are coming a little closer next week.
TLTRO a peashooter rather than bazooka
The December TLTRO – the second of the ECB’s cheap 4-year loans to banks - disappointed. Total borrowing by banks was EUR 129.8bn, while EUR 148bn was expected. The low take up by banks could reflect that market funding has becoming cheaper over the last few months, which makes TLTROs a less attractive alternative. It means that banks took up only around 50% of the maximum take-up of EUR 400bn over September and December. Given that there is EUR 270 bn of the 3-year LTROs maturing early next year, the TLTROs will not lead to a major ECB balance sheet expansion.
Sovereign bond purchases on the cards
It now looks close to impossible for the ECB to achieve anywhere near a trillion euro balance sheet expansion with its existing measures. It will need to broaden its asset purchases and sovereign bonds will need to be part of the mix. We previously thought that agency debt and corporate bonds would suffice.
Possibly even more than a trillion
Since the ECB first hinted at a trillion euro increase in its balance sheet in September, the outlook for inflation has deteriorated. At current oil prices, inflation would most likely decline to -0.3% yoy early next year from +0.3% yoy in the latest reading for November. Inflation will probably rise during the course of next year, but would be further away from 2% for even longer.
The very weak inflation trajectory over the coming months will raise concerns at the ECB of second round effects, where lower inflation expectations put downward pressure on wage growth and the inflation rates of other goods. Given the deterioration in the inflation outlook, there is a possibility that the ECB will signal that it intends to expand its balance sheet by more than a trillion at some point in the next few months.
QE in January
Overall, we expect the ECB to announce a broader programme of asset purchases at its January meeting. The inclusion of sovereign bonds and the eventual targeting of a more than trillion euro expansion would be a combination that will allow the ECB to get ahead of market expectations.
Joe six-pack is back
Last week’s economic reports were generally encouraging. The US consumer is going to town. Retail sales were up by 0.7% mom in November following a revised 0.5% in October (from 0.3% previously). What is more impressive is that the numbers were partly depressed by falling gasoline prices as they are values rather than volumes. Ex gasoline retail sales jumped by 0.9% following a 0.7% gain.
Lower energy prices are clearly giving US consumers more disposable income to spend on other goods. In addition, employment growth is accelerating and wage growth is finally showing signs of firming. The improving labour market means that the gains from the economic upswing are spreading, and this will lead to much stronger consumer demand.
Europe slowly turning, consensus too pessimistic
Data from the eurozone continues to turn gradually for the better. Eurozone industrial output was up by just 0.1% in November. However, output was partly depressed by the volatile mining and utilities sector. In addition, the outcome followed a 0.5% gain in October. Meanwhile, we saw continued signs of improvement in the labour market. Employment was up by 0.2% qoq in Q3 following a 0.3% gain in Q2. Most indicators suggest that a moderate recovery is underway and that economic growth in the fourth quarter will be a little better than in the third. Indeed, we continue to judge that pessimism on the eurozone economic outlook is overdone and that downgrading of growth forecasts for next year has gone too far.
China data mixed, but stimulus on the way
The latest batch of economic reports painted a mixed picture of China’s economy in November. Industrial production was clearly the weak link, with annual growth dropping to 7.2% from 7.7% in October and 8% in September. However, retail sales improved a bit (11.7% from 11.5%) and new loans (RMB 852.7bn from 548.3bn) rose significantly. We expect the authorities to continue to take steps to cushion the economy and keep the economic slowdown gradual. With inflation continuing to come down, the PBoC will likely ease monetary policy further. We expect another 50bp of rate cuts in the coming months. The government will likely announce a GDP growth target 7% for next year, compared to this year’s 7.5%.
Greece is back (but not in a good way)
Overall, we continue to expect a US-led rebound in global growth. However, risks remain, and a couple of them came in to sharp focus this week. First of all, there was an escalation of political risk out of Greece. The election of a new Greek President, which was on the agenda early next year, has been brought forward. The process, which could potentially trigger general elections early next year if unsuccessful, was scheduled for the first quarter, but will now take place later this month. A majority of 180 votes in the 300 seat parliament will be needed to elect the new President, while the coalition has 155.
Greek markets tumbled and investor sentiment softened. This reflects the fear that early elections will result in the Syriza party coming into government. It is against the economic adjustment programme. The Eurogroup has given Greece a two-month extension for its programme, which had been due to expire at year-end. Greece needs to complete certain reforms to obtain the last tranche of its programme. In addition, given its financing needs it probably need a precautionary credit line, which will also be conditional. The risk is that an unfriendly government could put Greece’s financing and hence financial stability at risk.
Still, it may not come to that. We think it is most likely that independents and deputies from other parties will help to elect the new President, which would mean elections would be unnecessary before 2016. In addition, even if there is an early election, a Syriza government might be more constructive than it appears. Over recent months, it has toned down its rhetoric, and softened its general stance, against the programme.
Russia also looking shaky
The other risk that came into sharper focus was Russia, where the central bank has been hiking interest rates in order to stop the slide in the Rouble, in vain. The central bank’s 100bp hike in its key rate earlier this week was treated with contempt in the currency markets.
More Russian rate hikes, more economic pain
This suggests that short of a quick and sharp bounce in oil prices, more policy rate hikes will be needed to stabilise the currency. This will lead to higher interest rates for consumers and businesses, which will weigh further on the economy. Indeed, a recession looks inevitable. The country has large currency reserves, so the authorities have some breathing space, but a severe financial crisis is a significant risk.
Fed to drop ‘considerable period’ guidance
Although Greece and Russia will undoubtedly remain ‘front of mind’, next week’s FOMC meeting could well steal the limelight. With the US economy going from strength to strength, the Committee well may decide to drop its promise to keep its policy rates on hold for a ‘considerable period’. However, with inflation subdued, it could replace it with a phrase that signals that rate increases are not imminent. We expect the Fed to start hiking its target for the fed funds rate at around the middle of next year.