From the FXWW room – A dovish Draghi is consensus, but it is likely too early to see a follow through. Most economists expect forecasts to be lowered (especially inflation) and a dovish press conference, but in terms of new commitment or action, we suspect the market will be left short. EURUSD still range bound between 1.08-1.17. Greater dislocation in EM FX will continue to pressure EURUSD higher. The potential of a Fed hike on 17 Sept will keep it from strengthening too much.
Bottom Line: A dovish Draghi is consensus, but it is likely too early to see a follow through. Most economists expect forecasts to be lowered (especially inflation) and a dovish press conference, but in terms of new commitment or action, we suspect the market will be left short. Directionally, this implies EUR will be sold over the statement/press conference, but with no significant adjustment to policy and NFP the following day, a commitment from traders should not be large. This leaves EURUSD still range bound between 1.08-1.17. Greater dislocation in EM FX will continue to pressure EURUSD higher. The potential of a Fed hike on 17 Sept will keep it from strengthening too much.
Citi continues to believe that the ECB will likely err on the side of caution, but policy will remain unchanged (see Euro Economics Weekly – ECB Preview: Dovish Tone Likely).
Our economists see cuts to both the HICP and GDP forecasts – with the inflation numbers bearing the brunt of the adjustment on weaker oil and a stronger EUR.
• We expect the 2015 HICP mid-point to be lowered by 0.2pp (to 0.1%), 2016 HICP by 0.2pp (1.3%) and the 2017 HICP by 0.3pp (1.5%)
• For GDP, we see 2015 mid-point cut by 0.1pp to 1.4%, 2016 unchanged at 1.9%, and 2017 raised by 0.1pp to 2.1%.
Fundamentally, there are two stories unfolding in the Euro area – improving growth (albeit more slowly), and weaker inflation. The former binds the ECB from being able to signal too strong a language change – which is a limit to the EUR weakness in our view. In its communications Thursday, risks should be increasingly skewed to the downside. These are an increasing uncertainty about the health of the global economy, increased market volatility, deterioration in China outlook, 30% fall in energy prices and increased disinflationary pressures.
Our economists see cuts to both the HICP and GDP forecasts – with the inflation numbers bearing the brunt of the adjustment on weaker oil and a stronger EUR.
• We expect the 2015 HICP mid-point to be lowered by 0.2pp (to 0.1%), 2016 HICP by 0.2pp (1.3%) and the 2017 HICP by 0.3pp (1.5%)
• For GDP, we see 2015 mid-point cut by 0.1pp to 1.4%, 2016 unchanged at 1.9%, and 2017 raised by 0.1pp to 2.1%.
Fundamentally, there are two stories unfolding in the Euro area – improving growth (albeit more slowly), and weaker inflation. The former binds the ECB from being able to signal too strong a language change – which is a limit to the EUR weakness in our view. In its communications Thursday, risks should be increasingly skewed to the downside. These are an increasing uncertainty about the health of the global economy, increased market volatility, deterioration in China outlook, 30% fall in energy prices and increased disinflationary pressures.
Still, it is not all bad. Leading indicators continue to point to an ongoing recovery in Europe, with momentum building to the topside. This should be clear from the advanced PMI’s as well as the German surveys such as the ZEW and Ifo. Additionally, we note that M3 at 5.1% YoY is the strongest print this year and before that 2009. The weaker ECB policy is clearly having an effect – and will encourage the GC to “stay the course” allowing enough time for it to fully unfold. Despite weaker China data and increasing concerns, one of the benefits to Europe and Germany in particular, is exports to China are not as sensitive to the exchange rate as may be initially assumed. We note that the current account firmly in positive territory, and increasing, both EUR positive developments.
However – the outlook on inflation has deteriorated since July, and this can’t be ignored by membership countries.
However – the outlook on inflation has deteriorated since July, and this can’t be ignored by membership countries.
Brent crude has fallen 13% since then, and market based measures of inflation expectations have collapsed again (Chart 4). In January of 2015 it was the tightening of real rates the ECB used as justification for starting QE, so it remains sensitive to any reversal of the trend. Nominal bond yields in Germany, Spain remain just above levels where QE was initiated (Chart 3) – so there will be an increased sensitivity to tightening of financial conditions – and the feedback for the economy. We see this as close enough to bear risks – but not sufficient to draw new action from the council.
Last point: Greece may have to wait on APP eligibility. Questions on Greek eligibility are certain to be brought up. Renewed purchases of Greek bonds would undoubtedly help flatten peripheral curves, and by derivative weaken EURUSD on rate differentials. Before this takes place however, the ECB would need to reinstate a waiver making them eligible for purchase. Recent comments by Benoit Coeuré suggests the ECB would need to judge if Greece has made sufficient progress on the remaining prior actions. With Greek elections slated for 20th September, we doubt the Greek government can deliver enough confidence beforehand – thus limiting the pressure on the ECB to reinstate a waiver in the immediate. A weaker EUR/flatter curves may have to wait.
In Summary: The EUR has corrected from its 1.17 highs – and a point most were expecting ECB to weigh in on, but it remains in the upper half of the range. Economic data (PMIs) are picking up – and M3 data is the highest its been this year (5.3% YoY). That gives a strong tailwind to growth – making it difficult for the ECB to sound too dovish until China weakness appears in European economic data (expect this in October and November). Weaker inflationary pressures will tend to dominate the risks and communications – and inflation forecasts will be lowered. Directionally, we expect EUR will probably be sold on the ECB forecasts/press conference, but bought back after.
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