Global daily insight 18 october 2016

Daily Insight

Group Economics Macro & Financial Markets Research

18 October 2016

Draghi to dismiss taper fears Macro & Financial Markets Research team Tel: +31 20 343 5616 nick.kounis@nl.abnamro.com

ECB preview: On hold in October, set to act in December - The ECB meets next week against the background of worries that the central bank will soon taper its asset purchase programme. These concerns look overdone to us. We think that the ECB will instead extend its QE programme and take steps to increase the eligible universe of assets before long.

With economic growth lacklustre, wages subdued, core import prices falling and inflation expectations dislodged, core inflation does not look like accelerating any time soon in our view. Indeed, fundamentals actually point in the opposite direction. We expect the ECB to take action at the December meeting rather than at this week’s one. Some ECB officials have suggested the Committees looking into changes to the QE programme will take time to report, while the Governing Council will also have the benefit of the updated staff macro projections in December. Still, President Draghi will have the opportunity to already dismiss tapering fears at the October press conference. To the expand the universe of assets, the ECB will likely decide to start buying bonds that yield less than the deposit rate (so far restricted) as well as buying bonds below the 2y maturity. Finally, we also expect that the ECB will relax the criteria to conduct substitute purchases. For more, see our note ECB Watch – ECB on hold next week, set to act in December (Nick Kounis, Aline Schuiling & Kim Liu) Global FX: Sterling correction looks advanced - Sterling has collapsed over recent weeks. It has fallen by close to 20% since the start of this year in trade-weighted terms, taking it to historical lows. Investors have started to price in the impact of a hard Brexit on the economy and the current account driven by the political stalemate between the UK and the rest of Europe. In addition, there is concern that an inflation surge will prevent the BoE from supporting the economy. Assuming a bumpy, but generally constructive EU-UK negotiation in our base case, sterling should gradually recover. The fall in sterling seen up until now would shrink the current account deficit to sustainable levels, and would lift growth as well as inflation. In addition, the basic balance is positive, suggesting financing for the deficit had been healthy pre-Brexit. What is more, speculative positioning is very extreme.

Speculative short positions are at their highest since inception in 1993. This means investors are already positioned for a lot of bad news, while the market would react more strongly than usual to good news if sentiment improves. However, an alternative scenario of a hard Brexit would widen the deficit further, and lead to a deterioration in capital flows. For more see our note FX Watch – Will sterling’s collapse continue?(Georgette Boele & Nick Kounis).

Fed view: Dovish Yellen discusses running a ‘high pressure economy’ - On Friday, Fed Chair Yellen held a speech at the Federal Reserve Bank of Boston on “Macroeconomic research after the crisis”. She mentioned that one of the gaps in the knowledge about inflation, concerned inflation expectations. She was mainly referring to how inflation expectations are formed and how monetary policy influences expectations. She suggested that it was unclear what the appropriate mix was between communication and concrete policy actions to demonstrate the commitment to reaching the inflation goal. During her talk Chair Yellen questioned whether after a deep recession, it was possible to reverse the

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Bloomberg: ABNM

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Daily Insight - Draghi to dismiss taper fears - 18 October 2016

adverse supply effects by temporarily running a “high-pressure economy”. Although the speech did not make any mention to when the next rate hike would be, Chair Yellen’s remarks are consistent with a very slow pace of rate hikes ahead. Lately central bank policymakers have been questioning the inflation framework from an academic perspective, given the weakness of certain relationships, including labour market tightness and wage growth. Ms. Yellen’s remarks have contributed to the sell-off in global bond markets, especially on the long end, as inflation fears built. Our view is that inflation will accelerate at a modest pace in the coming time, which is consistent with a rate hike in December and slow pace of rate hikes thereafter. (Maritza Cabezas)

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Daily Insight - Draghi to dismiss taper fears - 18 October 2016