ECB stimulus hopes grow

• US recovery signals remain mixed, as Yellen re-emphasises dovish stance
• Peripheral European bond markets surge on hopes of ECB stimulus; PMIs watched
• Late Easter to weigh on UK retail sales, but strong labour market data dominate

Major bond yields little changed... The major bond markets were broadly unchanged over the past week, impacted by mixed economic data and light trading volumes ahead of Easter. In the UK, 10-yr gilt yields ended the holiday-shortened week only a little higher, at 2.64%. The impact of the much stronger-than-expected labour market report (with the unemployment rate falling to 6.9%) was broadly offset by a further fall in UK CPI inflation (to a 4 1/2-yr low of 1.6%). Similarly, US yields were little changed, with a fall in the Empire Manufacturing Survey broadly counterbalancing a strong rise in US retail sales.


Peripheral euro bonds rally on stimulus hopes... Instead, the big movements over the past week have been in sterling FX and peripheral Europe. GBP/USD hit a new 5-yr high above $1.68, as the fall in UK unemployment prompted market participants to bring forward the timing of the first rise in Bank Rate. Over the week, the Dec-15 short sterling contract fell over 10bp. On the continent, peripheral bond spreads plummeted by over 20bp on growing expectations that the ECB may respond to the strength of the euro and stubbornly low inflation with further stimulus. ECB President Draghi is scheduled to speak in Amsterdam (Thurs). With Euro area inflation running at just 0.5%, markets will be listening closely for any reference to the exchange rate and policy ahead of the ECB meeting in early May.


ZEW raises downside risk for German Ifo... Data wise, the coming week sees the release of the ‘flash’ euro area and national PMIs, as well as the German Ifo. Following the surprise weakness of the ZEW expectations index, we expect a slight softening in the German manufacturing PMI (to 53.4 from 53.7) and Ifo (to 110.5 from 110.7). While further euro strength poses a risk to the German manufacturing recovery, its service sector appears to be holding up well. Strength here should be reflected in a broader improvement in the April euro area services PMI. Elsewhere, markets will be watching to see whether the French PMIs hold above 50.


US data eyed for signs of improvement... In the US, the mixed nature of recent economic data continues to cast doubt on the extent to which the earlier weakness is purely weather related. Creeping concerns about the pace of recovery appear to be emerging on the Fed, with Janet Yellen emphasising the uncertainty surrounding the outlook in a speech this week. At the same time, she stressed the likelihood that the fed funds rate would be kept unchanged for “a considerable time” after the Fed’s asset purchase programme ends.


Home sales still under pressure... Over the coming week, the US calendar is restricted to second-tier releases, including the latest leading indicator, durable goods and home sales (both existing and new). Durable goods and new home sales will be watched for what they infer about the strength of US Q1 GDP (due 30 April). While we expect the housing market to recover as the weather improves, the continued decline in pending sales points to further weakness in existing home sales in March.


UK retail sales and MPC minutes due... The Q1 GDP data are also due out in the UK at the end of April. The coming week’s March retail sales and public finance reports will help economists fine-tune their final growth estimates. The minutes of the April MPC meeting are also due. We suspect these will be very similar to those in February. Next month’s, however, could include a much wider discussion, as the fall in the unemployment rate below 7% means the MPC will no longer be constrained by its previous forward guidance.