Peter Vanden Houte, Chief Economist at ING, suggests that the combination of economic headwinds has finally managed to dampen the spirits of European businesses and households.
Key Quotes
“With inflation expectations now even lower than when the ECB started its quantitative easing (QE) program, more monetary easing is to be expected. The problem is that monetary policy has reached a stage where the marginal impact of additional easing threatens to become insignificant, a real life example of the dreaded liquidity trap Keynes described more than 80 years ago.
While we don’t expect the recovery to falter, the somewhat softer economic figures at the beginning of this year don’t signal an acceleration of the growth pace. Moreover, uncertainties are likely to continue to depress sentiment. In that regard, the fact that the migrant crisis is only increasing tensions within Europe and could even lead to an unravelling of the Schengen Agreement, can hardly be called a good omen. The run up to the Brexit referendum is also injecting a dose of uncertainty. We have therefore downgraded our quarterly profile for the first three quarters of 2016, now yielding 1.3% GDP growth for the whole of 2016.
While Bundesbank president Jens Weidmann continues to play down deflation fears, it seems likely that the ECB staff revises down again its projections for both growth and inflation. The first estimates for 2018 will be monitored closely by the Governing Council as potential justification for more action. While we believe that additional easing measures are a done deal, the ECB will have to walk on eggshells not to create an adverse market reaction as in December of last year.
In that regard, more of the same (a lower deposit rate and more QE) could be even counterproductive as creating additional excess liquidity at a more negative rate is an implicit tax on the banks. That might ultimately even force them to increase credit margins.
While we believe that the ECB will cut the deposit rate to -0.50% and increase monthly asset purchases by €5bn, mitigating measures will have to be put in place to limit the negative impact on the banking sector. A scheme that excludes a part of the excess liquidity from negative interest rates, or a two tier deposit rate, looks a real possibility. With spreads having increased in the bond markets, a broadening of eligible assets to corporate bonds for the QE programme, looks more likely than a year ago.
To prop up inflationary expectations, the ECB might reinforce its ‘forward guidance’. In discussions within the Governing Council it has already been suggested that the ECB should allow inflation to hover some time above target to make up for the undershoot in the previous years. This might be made more explicit in the forward guidance, potentially leading to a slight steepening of the yield curve.”
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