global perspectives

serious concerns about growth as ECB moves into assessment mode.

serious concerns about growth as ECB moves into assessment mode.
Charles St-Arnaud - Senior Investment Strategist

Charles St-Arnaud

Senior Investment Strategist

At its most recent monetary policy meeting, the European Central Bank (ECB) acknowledged that the economic backdrop in the Eurozone has been softer than expected, but stressed that it is assessing the persistence of such developments to see if the weakness will persist.  We deem this attitude the bank’s “assessment mode” and we highlight genuine concerns about growth in the Eurozone.

The ECB acknowledged that incoming information since the December meeting has continued to be weaker than expected.  But it also pointed to other factors underpinning the area’s expansion, such as supportive financing conditions, favourable labour market dynamics and rising wage growth.  As such, it painted itself as remaining in assessment mode, stressing that it is evaluating whether this deteriorating economic backdrop (and the uncertainties fuelling it) will persist.  

As a result, the central bank altered the language in the press statement to ‘the risks to the outlook have moved to the downside.’ This compares to its previous assessment that the risks were broadly balanced, but moving to the downside. In the current scenario, the bank expects that ‘significant monetary stimulus remains required’ and ‘the ECB remains ready to use all instruments as appropriate’ to reach its goal.

The meeting comes at an interesting economic juncture: since the central bank’s December meeting, global markets have corrected, with Bund yields reaching levels not seen since 2016, and more data signalling that the Eurozone economy slowed meaningfully in late 2018.  This backdrop has raised concerns about the Eurozone generally, especially in the face of geopolitical factors, a slowdown in China and emerging markets, and the threat of protectionism. We do not underestimate the potential for European populism to further brake regional economic developments. 

We have a genuine concern about growth in the Eurozone, as evidenced by the slowdown in German figures  recently and a potential slide into negative growth. Today’s meeting acknowledged that risk, though the ECB maintained that the risk of recession in the area is low and it is monitoring conditions.  This coincides with our Global Outlook for 2019 that posits a “No recession yet tricky” position.

How the ECB addresses this slowdown (if and when it proves more long-lasting) will likely be a matter of future developments and timing. We continue to believe that the likelihood the ECB will hike this year is very low. If anything, we believe that the ECB is more likely to provide some support to the economy via issuing a third wave of TLTROs (Targeted Longer-Term Refinancing Operations which provide attractive financing to Eurozone credit institutions up to four years). Those operations were mentioned by several policymakers at this month’s meeting, but the ECB has yet to take a decision, President Mario Draghi stressed at the press conference. We believe the bank is likely waiting until its 7 March meeting, when it updates its forecasts, to make a decision on such a measure.   

Language on forward guidance was kept unchanged, reaffirming that rates are expected to remain on hold through at least the summer, and for as long as necessary to ensure inflation converges to the bank’s targets.  This is something of a contrast with market pricing of future ECB hikes being pushed into 2020.  It seems very likely to us that the ECB could change its forward guidance in the near future to suggest no hike at least through 2019.  We would also raise the prospect that perhaps the ECB may be unable to hike at all in the current cycle if the economic deterioration persists. 

In addition to the impact of a weaker outlook on monetary policy, investors are likely to soon turn their attention to who will replace Mario Draghi as the President of the Governing Council at the end of the year. In our view, the leading contenders are Bank of France Governor Francois Villeroy de Galhau, and former chief of the Finnish central bank Erkki Liikanen, whereas the likelihood of Bundesbank President Jens Weidmann, or another German national being appointed are relatively low.

Investment implications: The deterioration in the economic outlook in the Eurozone and the increase in political uncertainty are reasons why we believe investors should be underweight European equities vs other equity markets, especially emerging markets. It also helps explain the underperformance of the sector relative to global equities. On the fixed income side, the limited upside in rates means that yields on European bonds are likely to remain low, making them more attractive despite the low level of yields, especially given the heightened uncertainty and weak growth outlook. In this asset class, we believe investors should focus on quality issuers in corporate space.

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