Yesterday was a busy day for central bank reporting, with 12 banks globally making announcements – four of them in Europe.
The European Central bank left monetary policy unchanged to no surprise. But what the market was really tuning in for, was the central bank’s growth and inflation forecasts up to 2020 – the first time it has forecast this far. Interestingly, the ECB seems optimistic on growth, hiking its 2017 forecast up to 2.4% from an earlier 2.2% . 2018 numbers have also been forecast upwards from 2.3% in 2018, vs an earlier 1.8% – showing increased confidence in the pace of Europe’s recovery.
Conversely, inflation forecasts remain stubbornly low. A 1.5% prediction for 2017 and 2019 remained unchanged, but a small upward hike in 2018, to 1.4% from 1.2%. Most crucially, the new inflation prediction figure for 2020 is 1.7% still well below the 2% inflation target. This reinforces our view that the central bank will remain accommodative for the foreseeable future, and any rate hikes as far as 2020 or 2021 are very unlikely.
Elsewhere in Europe, both the Swiss National Bank and the Norwegian Central Bank reported yesterday. The Norges bank seemed to be the more hawkish of the two, predicting 2018 mainland GDP to rise to 2.3% vs 2.0% seen earlier, and to 2.2% in 2019 vs 2.0% earlier. Inflation predictions have been hiked upwards to 1.7% in 2018 and 1.9% in 2019 vs 1.5% earlier. The Swiss National Bank reported expected GDP to rise to 2% but were slightly less optimistic on inflation predicting 1.1% in 2019.The UK’s Bank of England, Monetary Policy Committee also reported with policy left unchanged and no growth or inflation changes announced, maintaining its stance that inflation will remain slightly above the 2% target at the three year point.
Looking at the picture overall, we can clearly see more optimism about the recovery of the region, and it is encouraging to see the SNB and Norges Bank coming with some slightly more optimistic forecasts.
Further, a highly accommodative stance from the ECB has clearly boosted domestic demand, reflected in the optimistic revisions upwards for growth across the region. However, the fact that it continues to rule out any increase in interest rates while bond purchases are scaled back, in our view, signals ECB President Mario Draghi’s dovish stance, and he will continue to await evidence of more inflationary pressures before contemplating any further major policy shift.
But clearly, with growth doing well, and some small inflation forecast upticks – the deflationary fears for the region are firmly in the past. However, market reaction continues to be stagnant and mute, and yields on European bonds continue to remain at historic lows, and we are not seeing these bursts of optimism reflected in current yields. Against this backdrop, we continue to stay agile and flexible, searching for bright pockets of yield in key economies such as Poland and Italy, but also remain defensively positioned in core European bond markets with overall low duration in our portfolios.
David Zahn, head of European Fixed Income, Franklin Templeton Investments