Daily Insight
Group Economics Macro & Financial Markets Research
01 July 2016
BoE signals summer monetary easing Macro & Financial Markets Research team Tel: +31 20 343 5616 nick.kounis@nl.abnamro.com
BoE - The Governor of the BoE signalled that central bank would soon be easing monetary policy in a televised address. He said that 'the economic outlook has deteriorated and some monetary policy easing will likely be needed over the summer'. This reflected that 'it now seems plausible that uncertainty could remain elevated for some time' and that a 'material slowing' in economic growth was now the BoE's central scenario. Finally, he warned that there were limits to monetary policy, and that it could not 'fully offset the economic implications of a large negative shock'. The remarks sent sterling lower against the dollar and the euro (against the latter to its weakest since March 2014) and 10y gilt yields to a new record low. Mr Carney's remarks are in line with our base case scenario for UK monetary policy. We expect the BoE to cut the Bank Rate by 25bp to 0.25%. More importantly, we think it will launch a new QE programme, which will also include risky assets such as corporate bonds and perhaps eventually equities, as well as gilts. Global Macro - Eurozone inflation was back in positive territory in June. The headline rose to +0.1% yoy from -0.1% yoy in May. The rise was partly driven by a reduced drag from energy inflation (-6.5% from -8.1%). Though there was also an upward effect from service sector inflation (1.1% from 1%), which pushed up the core (to 0.9% from 0.8%). Despite the fall-out from the UK's vote to leave the EU, we continue to expect oil prices to gradually move higher in the coming months. Indeed, the swing in energy inflation is likely to see a sharp acceleration in the headline HICP, reaching around the ECB's target in Q1 of next year. However, we think that the ECB's focus will be on where inflation is heading beyond that (in 2017H2 and in 2018) and that will depend more on the trajectory of core inflation. This is because once the energy effect fades the headline will once again fall back to the core. We think core inflation will remain extremely subdued, meaning that overall inflation will continue to undershoot the ECB's target in the medium to long term. For starters, goods prices ex-energy are likely to slow further, pushing down core inflation in the coming months. This is because the upward impact from the past weakness in the euro on core import prices has faded and these are now falling. This will feed into lower goods price inflation. Second, we have revised down our forecast for eurozone GDP for next year on the Brexit fallout, and this also means that core inflation will be lower than we previously expected. We see headline inflation at 1.5% next year (down from 1.7% previously). We continue to expect the ECB to step up and extend its QE programme in the coming months. (Nick Kounis) Government bonds - In the days following the Brexit referendum and the outcome of the Spanish Elections, equity and peripheral bonds have rebounded from their lows. The positive sentiment in the market got another boost today, with the Italian Treasury successfully auctioning three bonds with different maturities, of which the 5 year bond was sold at a record low yield of 0.33%. The amount sold was EUR 6.75bn, which was the maximum of the announced target range. The so-called Bid-to-Cover ratios show that demand was abundantly available and was actually stronger than in previous auctions. The auction results underline the successful sale and the high willingness of investors to buy peripheral debt. The relief in the market and the subsequent rally in peripheral debt has partly puzzled us since uncertainty following the Brexit vote and Spanish election outcome is
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Daily Insight - BoE signals summer monetary easing - 01 July 2016
still high. One factor that can explain the strong performance of Italian bonds is that the auctioned amount was modest in size and that the market has started to price in more stimulus measures by the ECB. In addition, Italian bonds lagged Spanish bonds as yields on 10 year Spanish bonds dropped below the Italian comparable yield for the first time in nearly a year. However, we think that the relief in the market comes too soon and that it will fade away, with peripheral spreads rising again. Spreads could rise on the back of the Italian constitutional reform referendum pending in October, the vulnerable state of Italian banks, the uncertain outcome of the Spanish political negotiation talks and noise coming out of the UK-EU disentanglement talks. (Kim Liu) UK politics - The theater that is becoming the UK political scene following the referendum provided another chaotic act on Thursday as the Conservative leadership contest heated up. One of the leading contenders - the pro-Brexit former Mayor of London - Boris Johnson dramatically pulled out of the race. His Brexiteer ally during the referendum campaign Michael Gove - who was expect to back Mr Johnson - declined to do so and instead threw his hat into the ring. This seemed to open the door for the current Home Secretary Theresa May, who is now the front runner in the race to become the next Prime Minister. Mrs May is known to have relatively eurosceptic views but did back current Prime Minister Cameron in supporting the case for the UK to remain in the EU. She set out a number of key positions on Thursday. First of all, she said there should be no second referendum, the public had given its verdict. Second, Article 50 should not be invoked before the end of this year. Third, the government had no mandate to reach a deal that would maintain the free movement of people. This is crucial, as it will therefore make it difficult for the UK to have full access to the single market, given the EU's current stance. Finally, there should be no new General Election before 2020. (Nick Kounis)
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Daily Insight - BoE signals summer monetary easing - 01 July 2016
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Daily Insight - BoE signals summer monetary easing - 01 July 2016