The eurozone is still a region struggling with too much debt, too little growth, a strong currency and the threat of Japan-style deflation. This explains why the ECB is still adding monetary stimulus at a time when two of the world’s major central banks are moving closer to the exit.
Financial markets are still digesting the impact of the raft of easing measures delivered by the ECB at the June meeting. The negative deposit rate has so far had little or no downward impact on the euro and the effects of the potentially more powerful measure – the targeted long-term refinancing operations (TLTROs) – will only become apparent in the next 6-12 months. Meanwhile the eurozone survey and activity data have failed to impress and inflation has continued to surprise on the downside. Hence investors still believe that there will be more stimulus to come: purchases of asset-backed securities but also unsterilised purchases of government bonds, i.e. outright quantitative easing (QE).
QE has been our central view for about a year and remains so. However, it is increasingly becoming a consensus view and it is worth considering what might rule it out. Hence, we set out a number of signposts which would reinforce the view that QE is still on the cards or which could take the ECB down an alternative route.
The direct route…
Our inflation projections for 2014-15, at 0.6% and 0.8%, remain below those of the ECB staff, and the longer inflation stays so low, the greater the risk that it feeds into inflation expectations. We fear that such a low inflation outlook will continue to encourage cash-piling, delay investment decisions, curb hiring and lower potential growth – not only because of a shrinking capital stock, but because savings will increasingly be channelled into government financing given that public sector debt stocks are set to remain very high against a backdrop of such weak nominal growth.
While the ECB stopped short of announcing outright asset purchases in June, it has taken a step closer by suspending sterilisation of the government bond purchases it made under the Securities Markets Programme (SMP) in 2010-2011. The ECB also continues to leave the door open for large-scale purchases “when the inflation data warrant it”. We believe purchases of ABS could happen before end-year, but that full-blown QE would be more a 2015 story and only after projections for medium-term inflation have been lowered considerably and assuming there has been little or no pick-up in loan growth. We suspect the 2016 inflation forecast would probably need to be 1% or less.
A QE policy would be controversial and we admit it may not be as effective as hoped, but it at least holds out the prospect of weakening the euro and influencing inflation expectations, as long as it is framed in careful communication. It is also not without risks. Concerns about asset price inflation are already starting to surface, in terms of the implications not only for financial stability but also for income inequality. However, as the recent actions of the Bank of England and the Italian government have shown, these will have to be addressed by governments and regulators via macro prudential measures and taxes. The ECB’s primary mandate is price stability over the medium-term. We expect it to use the instruments at its disposal to try to meet it.
…but what if? The good…
Now that an expectation of QE is becoming increasingly priced into markets, the stakes could be high if the ECB fails to deliver. The expectation of eventual ECB asset purchases has played a key role not just in driving down peripheral bond yields but in driving the whole global hunt for yield. Hence it is worth considering what economic events could take the ECB down a different policy track.
Some of the alternative scenarios are positive for the real economy, if not necessarily for all financial markets. If the policies already announced have the intended effect, allowing credit growth to recover, wages to revive and investment growth to return, then the ECB forecasts for growth and inflation would remain on track and no further aggressive easing would be delivered.
The support could also be delivered externally. For instance, should 2014 finally be the year that US companies start to spend the glut of cash on their balance sheets and deliver the long-anticipated strong investment recovery, this could drive a much stronger than expected acceleration in US GDP growth, supporting a stronger expansion in world trade and therefore eurozone exports, quite possibly with an added kicker of a weaker currency as the market finally drives the dollar up.
…and the bad
Other scenarios which could prevent, or at least delay, QE are much less benign. In an environment of unresolved tensions between Russia and Ukraine and the ongoing conflict in Iraq, the prospect of an energy supply shock has reared its ugly head. In this low-inflation world the main impact of rising energy prices will be to hit growth as households’ real disposable incomes and corporate profitability are squeezed, but even a temporary rise in headline inflation to around the 2% level could at least delay further stimulus.
Domestically within the eurozone there is also a risk of ongoing fiscal slippage. Since May’s European Parliamentary elections, France and Italy have used the election result and the tussle over whether former Luxembourg Prime Minister, Jean-Claude Juncker, will become the new head of the European Commission, as an opportunity to demand more flexible fiscal rules in the monetary union. While we believe the ECB would be willing to embark on buying government bonds for monetary policy reasons if it is in danger of missing its price stability mandate, we think it would be difficult to do so if some large member states were relying on such a policy to fund larger budget deficits.
Forecast revisions
While we have acknowledged the various risks to our forecasts above, our central forecast is essentially the same as last quarter and is still below consensus. Our eurozone GDP growth forecasts are unchanged at 0.9% for 2014 and 1.1% for 2015 but we have raised our German forecast for this year from 1.7% to 1.9% and lowered our Italian forecast from 0.4% to 0.2% following the renewed contraction in Q1. Our eurozone inflation forecasts have been tweaked slightly lower to 0.6% and 0.8% in 2014-15. Our UK growth forecast for 2014 growth has been nudged up to 3.2% and we have moved our first rate rise earlier to February 2015 but even there we continue to lower our inflation forecasts. We have also revised up the growth forecasts (and lowered our inflation projections) for some of the Emerging European economies, notably Hungary, Czech Republic and Turkey, despite a further downward adjustment to our Russian forecast. Russia appears to have contracted again in Q2 but stagflation means that we have delayed the timing of our first rate cut by six months, from Q3 2014 to Q1 2015.
HSBC GDP and inflation forecasts
Latest figure
___________________ GDP ___________________
_________________ Inflation _________________
(Previous quarter)
2013
_____ 2014f______
_____ 2015f ______
2013
____ 2014f _____
____ 2015f _____
Eurozone
-0.4
0.9
(0.9)
1.1
(1.1)
1.3
0.6
(0.8)
0.8
(1.0)
Germany
0.5
1.9
(1.7)
1.7
(1.7)
1.6
0.8
(1.2)
1.5
(1.6)
France
0.4
0.7
(0.6)
1.2
(1.0)
1.0
0.8
(1.2)
1.2
(1.5)
Italy
-1.8
0.2
(0.4)
0.6
(0.6)
1.3
0.3
(0.4)
0.5
(0.5)
Spain
-1.2
0.7
(0.7)
1.1
(1.1)
1.5
0.1
(0.2)
0.5
(0.4)
Other Western
Europe
UK
1.7
3.2
(2.9)
2.5
(2.5)
2.5
1.6
(2.0)
1.6
(2.3)
Norway
2.0
1.9
(1.9)
1.9
(1.9)
2.1
2.3
(2.3)
2.4
(2.4)
Sweden
1.5
2.4
(2.7)
2.1
(2.4)
0.0
0.2
(0.2)
0.9
(1.2)
Switzerland
2.0
1.8
(2.0)
2.1
(2.1)
-0.2
0.2
(0.3)
0.6
(0.9)
Other Europe
Hungary
1.1
2.8
(2.2)
2.2
(1.8)
1.7
0.1
(0.8)
2.3
(2.6)
Poland
1.6
3.4
(3.2)
3.6
(3.6)
0.9
0.2
(1.2)
1.6
(2.0)
Romania
3.5
2.7
(2.7)
2.6
(2.8)
4.0
1.6
(2.3)
2.9
(3.1)
Turkey
4.0
3.2
(2.2)
2.7
(2.7)
7.5
8.5
(8.5)
6.6
(6.7)
Czech Republic
-0.9
3.1
(2.4)
2.9
(2.5)
1.4
0.5
(0.9)
2.0
(2.3)
Russia
1.3
0.0
(0.6)
1.0
(1.2)
6.8
7.1
(6.5)
5.9
(5.1)
Source: HSBC estimates
The full report including key European forecasts and statistics is available at www.research.hsbc.com