Macro: Sandcastle economics
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ECB Preview: More is better
Christopher Dembik
Head of Macro Analysis
Summary: The ECB monetary policy meeting will take place on October 29 against a worsening economic backdrop. Tomorrow's European PMI for October should confirm that risks to growth are tilted on the upside after an initial strong economic rebound in Q3 following the lift of the lockdown. We are onboard with consensus expecting no policy change at that meeting. However, given the deteriorating situation on the pandemic front and the implementation of further restrictions all over Europe, the central bank is likely to adopt a more dovish stance, thus opening the door to further accommodative measures by year-end.
In our view, there is no debate that the ECB will be compelled to ease further monetary policy by year-end, more probably at the December meeting when the new staff projections will be released. After a strong rebound in economic activity in Q3, following the lift of the lockdown, there is an accumulation of evidence pointing out to the risk of outright quarterly contraction in Q4 on the back of further COVID-19 spread and new restrictions. Just today, as Europe is struggling with rising coronavirus cases, the Greek prime minister has announced new measures in televised address, Czech Republic has re-imposed a semi-lockdown starting today, and a curfew has been decided in two Italian regions. We believe the most vulnerable countries are Spain, France and the Netherlands with GDP contraction potentially ranging between -1% and -1.3% next quarter.
At this point, this is a guess as we lack hard data to confirm this scenario. But there are already indications of slowdown in the economic recovery. This morning, Germany’s GfK consumer confidence for November was out at a 4-month low, at -3.1 versus -3.0 estimated. The survey found that more than half of respondents had “major concerns” over the economic impact of the virus on them personally. In addition, the widely-commented Google’s mobility statistics tend to corroborate that the eurozone recovery is going backward. After a strong but partial rebound in Q3, the visits to retail & recreation stores, one of the most affected sectors by the pandemic, are going down again. One of the most worrying trends is in Spain where the visits are down almost 30% compared with the baseline as COVID-19 cases rise sharply and semi-lockdown measures are re-imposed. Based on that, we think there is a significant risk of a negative economic surprise in Q4 in the eurozone.
Explanation: Mobility data are released by Google in its COVID-19 Community Mobility Reports. These reports are published on an ongoing basis, with the most recent statistics referring to the situation as it was two to three days ago. The above chart refers to the trend in terms of visits and length of stay in the retail & recreation sector in the main eurozone countries.
Tomorrow’s European PMI for October are the latest major European data to be published before next week’s ECB meeting. They should clearly confirm that risks to growth are tilted on the upside and that activity in the manufacturing sector is still more resilient than in the services sector due to renewed Chinese demand. Disappointing figures could push France's Christine Lagarde to double-down on the European Central Bank's dovish monetary easing stance next week, but we think the central bank will patiently wait for the new staff projections in December to trigger new measures. A recent ECB working paper entitled “Does a big bazooka matter? Quantitative easing policies and exchange rates” published earlier this week gave us clues on which instrument the ECB may use. This working paper constitutes a clear and consistent signal that a new increase in QE is more likely than a rate cut. At the December meeting, we think the ECB will confirm its commitment to buy almost all the newly issued euro area public debt as long as the pandemic continues to weight on economic activity and that disinflationary pressures persist. So far, according to our calculations, the ECB has purchased more than two third of the sovereign bonds issued since the outbreak, which is a greater amount than that of the Federal Reserve (around half of T-bonds issued since the outbreak), but lower than that of the Bank of Canada (roughly 80% of bond issuance). Thus, it is likely to announce on this occasion an increase in the PEPP (Pandemic Emergency Purchase Programme) envelope of €500 billion to €1,850 billion and no change to the APP (Asset Purchase Programme). Further accommodation via an increase in the amount of asset purchases will probably reassure investors and could create further incentives for governments to resort to higher spending, the most efficient tool left, to cope with the crisis beyond 2020.
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