Global daily insight 27 october 2016

Daily Insight

Group Economics Macro & Financial Markets Research

27 October 2016

Hints of ECB QE extension Macro & Financial Markets Research team Tel: +31 20 343 5616 nick.kounis@nl.abnamro.com

ECB view: Hawk Hansson sounds dovish, while Reuters reports QE will continue – The Estonian central bank Governor and ECB Governing Council member Ardo Hansson made some dovish remarks in Tallin. He said that ‘some weakness can be seen (in) core inflation, where we can’t yet see a very clear trend for improvement’. He also said that wage growth – a key driver for core inflation in the future – ‘remains rather modest in some regions’. His comments are striking as Mr Hansson is clearly one of the hawks in the Governing Council. In addition, his remarks suggest that the key condition for the ECB to start to wind down its QE programme is not being met. Indeed, at the December press conference, ECB President Draghi asserted that asset purchases will continue until ‘the Governing Council sees a sustained adjustment in the path of inflation consistent with its inflation aim’. Separately, a report from Reuters cited ECB sources saying that the central bank is almost certain to keep buying bonds beyond March and relax its constraints on the purchases to make sure it finds enough securities to buy. According to the article a range of options to do this are being discussed, and a decision on which one or combination has not been made. We continue to think that the ECB will expand the duration of its QE programme from March 2017 currently to September 2017 in December. To 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. (Nick Kounis) Global government bonds: Revisions to our yield forecasts - During the weekend, there was positive news on Portugal and Spain. First, the rating agency DBRS kept its assessment of Portugal at investment grade and its outlook stable. Second, Spain’s Socialist Party decided to support Mr Rajoy’s minority government, ending the political deadlock. The positive news has eased immediate concerns, although the former will continue to face an unpleasant cocktail of high debt and low growth. Nevertheless, we expect that the positive outcome will result in a relief in the market. We have therefore revised our 2016 end of year yield spread forecasts over 10 year German bonds down from 350bp to 275bp for 10y Portuguese bonds and from 120bp to 100bp for Spanish bonds. The key political risk event in Q4 remains the Italian referendum. Although polls show that it will be a close call, our base case scenario is relatively benign as we expect that independently of the referendum outcome, no new elections will be held. Although it is likely that in the run up to the referendum, Italian government bonds will underperform, we expect that at the end of the year these losses will be pared. We now expect that the yield of 10y Italian bonds will decline to 120bp over German bonds. Finally, as peripheral risks have eased, we have revised our yield forecast for 10 year German bonds slightly upwards to -10bp at year end (from -20bp). Though we continue to think that the ECB’s policy announcements in December will support Bunds (see above). Also our forecast for 10 year Treasury yields has been revised upwards to 1.80%, although our base case scenario of a snail-paced rate hike cycle (one rate hike in December and 2 rate hikes in 2017) remains unchanged. (Kim Liu)

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Daily Insight - Hints of ECB QE extension - 27 October 2016

BoE view: Carney suggests sterling fall will keep policy on hold – Earlier in the week BoE Governor Mark Carney suggested that the central bank will probably not cut interest rates again in the near term. In comments to the House of Lords Economic Affairs Committee, he said that ‘there are limits to the MPC’s willingness to look through an overshoot of inflation’. These comments are closely related to the likely overshoot of the BoE’s 2% inflation target in coming years due to the sharp drop in sterling. We estimate that the combination of the fall in sterling and the declining drag from energy prices will push up CPI inflation by around 2 percentage points. It currently stands at 1%. The MPC has signalled that CPI inflation could be around 2.5% during the BoE’s 2-3 year policy making horizon. Hiking rates on the back of the fall in sterling, while the economy is weak, does not look likely at this stage. However, we do think the BoE will keep its policy rate on hold going forward. (Nick Kounis)

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Daily Insight - Hints of ECB QE extension - 27 October 2016