Three trigger points that could spur further action from the European Central Bank
Ahead of tomorrow’s meeting, Wouter Sturkenboom, senior investment strategist EMEA at Russell Investments, highlights three trigger points that could spur further action from the European Central Bank (ECB).
“The focus of tomorrow’s ECB meeting will be on the start of its purchases of asset back securities and covered bonds and what we imagine will be a firm denunciation of the rumours surrounding plans to buy corporate debt. Of course, such a denunciation will be sugar coated by Draghi by referring to the willingness of the Governing Council to do more if needed.
“We believe there are three developments that could trigger the ECB to take further action to support growth and boost inflation expectations:
- Inflation expectations fall and the 5y5y inflation swap rate falls meaningfully below 1.8%. This is now a toss-up, but given the impact of lower energy prices, we expect the ECB to wait and see for now.
- Loss of growth momentum continues and threatens to push trend growth down into a triple-dip recession. For this to happen PMIs will need to fall below 50, the IFO index will need to fall below 100 and consumer confidence will need to fall below -20. These levels have not been reached and the PMIs and consumer confidence actually rose marginally over the month.
- Bund yields fall decisively below 0.8% and the average spread of Italian and Spanish debt vs Germany rises above 175bps: we briefly dipped below 0.8% in the global government bond rally but have since retraced to 0.83%. To differentiate this watch point clearly from the 5y5y inflation expectation, we include the Italian/Spanish spread level. This combination captures both falling growth and inflation expectations as well as Eurozone tensions.
“Regarding the challenge of falling inflation expectations and a loss of growth momentum, we presume Draghi will reiterate earlier views. That is, on inflation he will underline the impact of a lower euro and energy prices while acknowledging the risk of declining medium term inflation expectations. On growth he will repeat the need for fiscal and monetary policy to reinforce each other.
“We believe that the Eurozone will not drag the rest of the world down. For UK pension funds, it means that maintaining or increasing inflation hedging makes sense at current attractive levels, and also that portfolios should continue to position to benefit from a global recovery.”