UPDATE 1-Euro zone markets set high bar for ECB surprise

30 Nov 2015 | Author: | No comments yet »

ECB Draghi’s Deflation Antidote Is Beginning to Work: Analysis.

NEW YORK (AP) — Stocks edged slightly lower in quiet trading Monday as traders returned from the Thanksgiving holiday. Euro-zone government bonds interrupted this month’s rally as investors questioned whether European Central Bank policy makers will boost stimulus enough to push yields lower.FRANKFURT: The world’s two biggest central banks will move decisively in opposing directions in the coming week, with the ECB almost certain to ease policy on Thursday and a US jobs report likely to seal the case for a Fed rate hike in December. Securities from Germany to Portugal gave up some of their gains, after weeks of speculation of increased easing by the ECB had pushed many of the yields on the region’s two-year notes to record lows in November. Economists surveyed by Bloomberg unanimously predicted officials will increase stimulus again this week, less than halfway through the ECB’s quantitative-easing program, and most foresee multiple measures.

Market-based inflation expectations, rising since last month on base effects and seasonalities, got a further nudge up after Draghi said on Nov. 20 the ECB “will do what we must to raise inflation as quickly as possible.” Some signs that the region’s large output gap is narrowing have already emerged although it is a very long road ahead for return to full use of capacities, erasing of inventories and tightening of labor markets, in stark contrast to U.S. Even after flooding 445 billion euros ($470 billion) into the Eurosystem via public-sector debt purchases through Nov. 27, the ECB and President Mario Draghi are still struggling to stoke inflation. Manufacturing and services PMIs have been on an encouraging upward trajectory this year, which is also borne out by pickup in European Commission services confidence. The ECB will contemplate a wide range of measures, from a fairly uncontroversial deposit rate cut to more extreme — but highly unlikely — moves such as buying rebundled non-performing loans to resurrect bank lending. “With expectations high, the risk of disappointment is also high but as concerns are correctly focused on the structural headwinds to the inflation outlook, there is really no point in holding back or saving ammunition at this stage,” Societe Generale said in a note to clients.

With expectations so high, “Draghi cannot beat them, but only meet them,” said Marius Daheim, a senior rates strategist at SEB AB in Frankfurt. “If the ECB includes other asset classes in its asset-purchase program, this takes some downside pressure off government bond yields. The cost of insurance to protect against inflation going above ECB’s 2 percent target has recently edged higher, and is now above the record low hit in December 2014.

IN CONTRAST: While the ECB moves toward increasing stimulus, the Federal Reserve is getting ready to start raising interest rates for the first time since June 2006. A series of U.S. economic reports this week, culminating with Friday’s jobs survey for November, could cement investors’ expectations for a rate hike at the Fed’s next policy meeting in mid-December.

The biggest complication to all this is the small but significant group of opponents to such action, led by Bundesbank chief Jens Weidmann and board member Sabine Lautenschlaeger, who broke ranks with their Governing Board peers recently to openly oppose further easing. Arguing that loose monetary policy poses risks and merely buys time to fix structural problems, Lautenschlaeger has taken a stance against any more steps, especially an expansion of the asset-buying programme. The latest two-year sovereign yield to tumble to a record was the Dutch, touching minus 0.401 percent on Monday, the least since Bloomberg began collecting the data in 1994. Draghi may have his work cut out bridging the gap between their views, as the ECB rarely votes at meetings and instead decides on policy with the broadest possible consensus. The 13.7 billion euros of government debt bought in the week to Nov. 27 under the ECB’s program was the largest amount since the second week of QE in March.

Markets may need to see actual realized inflation before generating a convincing upward trend, given Japan’s unsuccessful attempts to revive inflation. His opponents could also make it tough for Draghi to continue his practice of promising big things, then exceeding the already heightened expectations. “Expectations have increased further ahead of next week’s ECB meeting and ECB speakers have not done much to rein in expectations. Realized inflation will likely get a leg up over the next few mos. due to base effect from the steep declines of oil in fourth quarter of 2014, but that should be no surprise. Third-quarter ECB Survey of Professional Forecasters shows inflation will reach 1.5 percent in two years, compared with 1.2 percent estimated in March.

Citigroup said that to surprise the markets, the ECB would need to cut the deposit rate, increase its monthly bond-buying and adjust its forward guidance by extending the programme or removing its reference to ending it next September. Retail stocks fell after initial data from Black Friday and the first holiday shopping weekend showed shoppers were not going to stores as much as last year. Data on Friday is expected to show that US non-farm payrolls increased by 200,000 in November, keeping the jobless rate at a 7-1/2 year low of 5.0 per cent. A 10 basis-point cut to minus 0.3 percent is fully priced in, according to futures data compiled by Bloomberg, while the lowest forecast in a Bloomberg survey was for a reduction to minus 0.45 percent.

But even if the figures disappointed somewhat, the Fed is still expected to hike at its meeting on December 15-16 given near full employment, with the debate likely shifting to future rate hikes rather than near term moves. The biggest headwind for the Fed could be the dollar’s rapid firming against major currencies in recent months, which has already effectively tightened monetary conditions. Fed Chair Janet Yellen’s testimony to the Joint Economic Committee of the Senate on the economic outlook, due at the same time as Draghi’s press conference, will likely give more clues about the Fed’s next moves.

Among other top central banks, the Reserve Bank of Australia and the Bank of Canada are both expected to keep rates on hold with their respective economic outlooks in line or slightly better than their previous forecasts.

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