Will disinflation sway the Fed?

• Euro focus shifts to Greece amid strengthening support for Syriza
• FOMC rhetoric to hold steady amid ongoing signs of disinflation
• UK economy to report another quarter of above-trend growth

ECB bazooka boosts market sentiment, but further questions lie ahead... The ECB’s announcement this week of a €1.1 trillion asset purchase programme delivered a significant shot in the arm for market sentiment. Furthermore, ECB President Draghi made it clear that the programme could be extended should conditions warrant in order to bring inflation back to target. This, coupled with lowered costs associated to future TLTRO programmes, helped the rally in global equity markets continue. Whether the risk sentiment can be maintained over the coming week will hinge upon the outcome of the Greek elections and messaging from the Fed.

Euro focus turns to Greece... Following the ECB’s decision, however, the Greek elections present the next hurdle for risk sentiment as the Greek electorate take to the polls to elect a new parliament on Sunday. According to latest polls, the left-leaning Syriza party’s lead over the New Democracy party has widened and outright support for the party has increased, raising the likelihood that it emerges as the single largest party, forming either a minority government or a coalition involving one of the smaller parties. We view the latter as being the more likely outcome. As the outcome of the election may cause frictions in Greece’s relationship with the rest of Europe, the exit polls which are due to be published from 5pm GMT onwards on Sunday, will be keenly awaited with market impact likely to be felt on Monday.

Central Bank spotlight shifts to the FOMC... Following the surprise shift in the voting pattern at the Bank of England, the focus in the coming week shifts to the outlook for US monetary policy. The minutes of the January MPC meeting suggested that the Committee were now seemingly united in the need to keep policy unchanged in the UK, as concerns over the prevailing weakness of inflation formed the single biggest consideration for the MPC. In contrast, the FOMC have hitherto been more minded to look through the ‘temporary’ softness in headline inflation. In December, the FOMC moved away from the use of “considerable time” in its policy rate guidance in favour of “(the fed) can be patient in beginning to normalize the stance of monetary policy.”, providing a clear signal of their intention to deliver the first rate hike in 2015. While this view will have been strengthened by the subsequent upward revisions to Q3 GDP, the Committee’s assessment of the inflation outlook will be closely watched in light of the continued decline in oil prices; the circa 6% rise in the dollar index since the last meeting and the unexpected drop in December pay growth. The Employment Cost index for Q4 will provide a cross-check on the extent to which the softening in the pace of growth in Q4 average earnings is reflected in overall labour costs.

US activity outlook remains firm... Following the rapid pace of expansion in Q3, US GDP growth is expected to have remained firm in the fourth quarter, albeit at a more moderate pace. We expect the economy grew at a solid annualised pace of 3.5% in Q4. Ahead of this, December durable goods orders (Tues.) are forecast to show some stabilisation following September’s 0.9% decline. Consumer confidence surveys from the Conference Board (Tues.) and Uni. of Michigan (Fri.) are also expected to remain relatively upbeat, along with the Chicago PMI (Fri.).

Domestic activity still buoyant... Despite growing concerns over the inflation outlook in the UK, the preliminary estimate of Q4 GDP (Tues.) is forecast to report another quarter of above trend quarterly growth. Later in the week (Fri.) money supply, mortgage approvals and consumer credit are also due.

Euro area inflation to fall further... Following the ECB’s QE announcement, the inflation outturns over the coming months remain of interest. In the near term, the downtrend is likely to have continued. We forecast the preliminary release of January euro area inflation (Fri.) to have recorded a second consecutive month of negative inflation at -0.5% y/y from -0.2%. While in Germany the IFO survey is forecast to have ticked up to 106.8 from 105.5 in light of the firm reading from the ZEW survey earlier this week.