Mario Draghi joins the optimists

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Mario Draghi

ECB President Mario Draghi struck an upbeat tone. The institution’s growth forecasts were revised up significantly, while inflation is seen returning to its goal during 2017. The message was that QE is going to work and indeed is already having positive effects, even though it will only start next week. Data supported the ECB’s new optimism, with economic growth set to pick up in Q1. Meanwhile, the US employment numbers were again impressive, while Asia’s monetary easing cycle continued. China’s authorities indicated a new growth target of 7%, which was in line with our expectations.

Indeed, Mr. Draghi stressed that the positive forecast assumed the policy was implemented in full. Nick Kounis Nick Kounis Head of Macro Research

Positive on the effects of QE

ECB President Mario Draghi gave himself and his colleagues a big pat on the back for a job well done following the Governing Council meeting yesterday. He said that the QE announcement had ‘worked’. It had already led to a ‘significant number of positive effects’. In particular, ‘borrowing conditions for firms and households have improved considerably’.

Growth revised up

The ECB raised its growth estimate to 1.5% for this year from 1% previously, and it now stands just below our own forecast. However, compared to most forecasts, the ECB is now in the optimistic camp, with the OECD at 1.1% and the IMF and the consensus of economists at 1.2%. The fall in the euro and oil prices and the impact of QE were the main factors driving the upward revision.

Inflation to reach goal in 2017

The fall in oil prices led to a reduction in the ECB’s inflation forecast for this year, but it raised its projection for 2016. In addition, it expects inflation to rise back to around it price stability goal in 2017.

QE unlikely to end early

All this does not mean that QE is no longer necessary. Indeed, Mr. Draghi stressed that the positive forecast assumed the policy was implemented in full. This makes it likely that asset purchases will continue until September 2016, as previously signalled.

Purchases will start on Monday

The ECB also published some more details about the programme. It will start on Monday (9 March). National central banks will focus on their domestic markets and will have some flexibility in deciding the mix of government bonds and agencies they purchase. Purchases will include negative yielding bonds, up to a lower limit of the ECB’s deposit rate, which stands at -0.2%. My colleague Kim Liu analyses the details of the programme in the Rates Weekly in more depth.

ECB staff projections

Crunch time for the bond market

What remains clear is that the ECB’s programme will continue to have a major impact on financial markets. The demand-supply balance for high quality securities is already very tight. Regulations mean that financial institutions not only want to hold to their bonds, but in some cases want to add to them. The entrance of the ECB will add a big new buyer and will create a scarcity of core government bonds, which will depress their yields.

Good for risk assets, bad for the euro

As the ECB’s QE started to come into view, we have seen risky assets rallying and the euro dropping. The lesson from the US experience is that these portfolio rebalancing effects could continue for some time. We think the positive trends in European equities, corporate bonds, and peripheral government bonds have a way to go. Meanwhile, the euro will likely fall further.

The lucky general

Apparently Napoleon said that he preferred his generals to be lucky rather than good. The ECB President is certainly lucky in his timing. The policy is starting at time when a number of favourable headwinds are already supporting the economy and the economic data is turning. So QE is swimming with the tide rather than against it. This was confirmed by the eurozone data over the last few days.

Eurozone consumer is back!

Retail sales jumped by 1.1% in January, following a 0.4% gain in December. At 3.7%, annual retail sales hit their highest level since August 2005. Clearly consumers are spending a significant proportion of the huge windfall gains from the decline in oil prices. Meanwhile, German industrial production rose by 0.6% in January, which is impressive given it follows a 1% jump in December. Admittedly, German factory orders were weak, slumping by 3.9%. However, these numbers are volatile and orders surged by 4.4% in December.

Estimated windfall from oil price drop

US labour market still buoyant

On the other side of the Atlantic, data suggested the US economy remains in rude health. Nonfarm payrolls rose by 295K in February after a 239K rise in January. This leaves underlying employment trends looking very strong. Wage growth was modest in February, with hourly earnings rising by just 0.1%. However, that followed a 0.5% jump the previous month. With unemployment continuing to fall sharply (5.5% in February following 5.7% in January), we think wage pressures will become increasingly visible in coming months. Our expectation remains that the Fed will raise interest rates for the first time in June, with risks skewed towards a somewhat later move.

China sets 7% growth target

There was also big news in Asia. China’s Premier Li announced that the authorities will target a 7% growth rate this year, compared to the 7.5% target last year. This reflects the ongoing structural adjustment efforts of the authorities to rebalance the economy from heavy industry and property to consumer spending and services. This is intended to lead to a more sustainable growth model. The new 7% target is in line with our expectations.

Asia’s easing cycle

We expect China’s authorities to ‘defend’ the growth target by stepping on the gas or the breaks, as needed. Indeed, they have recently put looser macro policy settings in place to ensure growth does not undershoot the target. The PBoC cut its key rates last weekend. We expect further easing ahead. Meanwhile, India’s central bank followed suit. The RBI cut its repo rate by 25bp, reflecting the improving inflation outlook.


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