global perspectives

Pervasive uncertainty - ECB changes course and delays exit

Pervasive uncertainty - ECB changes course and delays exit
Salman Ahmed, PhD - Chief Investment Strategist

Salman Ahmed, PhD

Chief Investment Strategist
Charles St-Arnaud - Senior Investment Strategist

Charles St-Arnaud

Senior Investment Strategist

Today’s European Central Bank (ECB) meeting on monetary policy led to a stronger-than-expected dovish shift from the central bank, albeit one that was in line with our expectations.

The serious slowdown in growth momentum in the Eurozone in recent months seems to have spurred the pivot, as the ECB not only announced a fresh round of low cost loans for banks, but also pushed back the timing of its anticipated rate hikes. The bank considerably reduced its economic projections, as well.

As such, the bank unveiled another dose of Targeted Longer-Term Refinancing Operations (TLTROs) with a 2-year maturity that will commence in September 2019. It also changed its forward guidance on rates, pushing back the expectation of its first rate hike until the end of 2019, at least. Previously, the bank expected rates to stay on hold only through the summer. 

In addition, the ECB’s downward revision to its growth and inflation forecasts suggests that scope for further policy changes (should current conditions persist) remains wide open. As part of its lowered forecasts, the ECB accepts that inflation will be meaningfully below-target over the forecast horizon. The fact that the bank continues to forecast below-target inflation, despite its latest policy measures, implies that the bank’s current policy is inconsistent with its mandated inflation target.

As we have noted recently, macroeconomic conditions in the Eurozone are deteriorating quite fast, led by the manufacturing sector. While we acknowledge the role of one-off factors, the “pervasive uncertainty” that ECB President Mario Draghi referred to continues to worry us, especially when it comes to the growth and inflation outlook in the area.

Looking ahead, the choice of the incoming Governing Council President will be critical in shaping ECB policy in coming months. It is widely acknowledged that the policy arsenal available to the central bank is limited, especially in the event of a pronounced recession. Indeed, by pulling the economic forecasts sharply down over the forecast horizon, the ECB has prepared the ground for further easing, should the next President continue to shape policy in a similar vein to Draghi.

Investment implications: Overall, given the rise of populism sweeping across Europe currently, we think it is a political imperative for the ECB to reduce the likelihood of a recession. The bank could justify further policy measures as action needed to ensure that the inflation target is met over the forecast horizon. We expect sustained downward pressure on sovereign European bond yields and, coupled with the Federal Reserve’s dovish pivot, we think a search-for-yield-environment is likely to take hold once again in global risky asset markets.

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