Draghi to remain Dovish

No new measures to be announced

Draghi to keep the line on duation and size of its asset purchase programme

Staff growth forecasts to show no major differences compared to March

Staff inflation forecast for 2015 to be raised, but not 2016/17

Questions on Greece to be circumvented

There are no new decisions expected at Wednesday’s ECB meeting, but that doesn’t mean that it won’t be interesting. We get the new ECB staff forecasts and there will be a lot of questions about the comments of ECB Coeuré on the logistics of the purchases programme. Last but not least there is Greece and the attitude of the ECB. We expect ECB president Mario Draghi to keep a dovish stance, but incite governments to do more about economic reform.

ECB Coeuré causes some confusion

In general, the ECB should be satisfied by most recent developments in relation to the roll-out of its purchases programme and the modestly improving health of the Euro area economy. Admittedly, there was some unrest when bond yields suddenly rose at the end of April and first half of May. The German 10-year yield increased without a specific reason from 5 to 77 basis points. As US yields rose less and the rate differential increased, the euro strengthened from 1.05 to almost 1.15. While some volatility cannot be avoided in markets, it seems to have made ECB governors nervous. It is maybe no coincidence that ECB Coeuré said that the ECB would buy somewhat more bonds in May/June and less during the summer months due to presumably limited liquidity. Calm on the markets returned, maybe partly because of Coeuré’s comments. Importantly, the euro weakened again (to about 1.09 against the dollar) and yields eased about 25 basis points. Equities more or less stabilized, keeping overall financial conditions in the Eurozone very favourable. We expect Draghi will downplay the Coeuré comments and show no signs of panic about the recent market volatility, which he will qualify as part of natural market behaviour. The main message of Mr. Draghi probably will be that the ECB remains committed to the seize and duration of the asset purchase programme, that he will argue as successful till now.

Lending remains the weak spot

M3 money supply continued to increase faster, up now 5.3% Y/Y in April from 4.6% M/M previously. Despite the sustained uptrend in M3, lending data remain sluggish.
Lending to the private sector increased by only €9 billion in April, sharply down from the €21 billion increase in March, a disappointment following some better figures in previous months. We don’t know whether the timing of Easter may have played some role or whether this simply reflects a continuing reluctance on the part of the private sector to add significantly to what are in many instances already substantial debt levels. Loans to households rose by a meagre €4 billion with the annual growth rate staying flat. A slight increase in lending for house purchases (€6 billion from €7 billion) was partly offset by a decline in consumer credit and other lending. Loans to non-financials were flat from the previous month, when they dropped by €3 billion. Still, the annual rate of contraction eased marginally from -0.6% Y/Y to -0.4% Y/Y. Despite the ECB’s measures to boost credit supply, the money is not filtering through into the real economy. After a few months of encouraging signs, lending is sputtering again as the recovery remains too slow to boost investments and lending. Lending data will of course remain an important variable for the ECB and thus a good reason to keep their unconventional easy policy stance intact.

Economic data stabilize more or less

The economic situation in the Euro area has more or less stabilized but the latest batch of data have underlined previous ECB warnings that recovery was likely to be gradual and uneven rather than sharp and universally felt.
The most recent business and consumer confidence indices no longer improved and some hard data like the, albeit not so reliable, retail sales were weak. Geographically, the economies of the periphery are doing better and making clear progress, but the German economy disappointed somewhat of late and the French economy is still functioning at a low level. Overall, the Euro area economy may have grown in the second quarter at a similar 0.4 Q/Q pace to the first quarter, even if a lot of economic information on Q2 is still missing. So, we expect Mr. Draghi to ask governments to do more to reform their economy and make it more competitive. We think the staff estimates will be broadly in line with the optimistic March forecasts at 1.5%, 1.9% and 2.1% in the period 2015-17. These forecasts will emphasise ECB confidence that the asset purchase programme will succeed.

Inflation became positive again

In April, headline inflation left negative territory (0% Y/Y), while core inflation stabilized at a record low 0.6% Y/Y. For May, EMU inflation went up slightly faster than expected to 0.3% Y/Y while the core CPI jumped from an upwardly revised 0.7% to 0.9%. In our detailed monthly study of euro area inflation, based on the final CPI report, we see signs that the deflation risks are receding (See our flash).
Market expectations derived from the swap curve on the contrary shows that the 5-yr/5y forward inflation slightly drops back to 1.75%, but stays above the 1.5% low at the start of the year. The March staff inflation forecast was 0% in 2015, 1.5% for 2016 and 1.8% for 2017. We expect an increase of the 2015 figure, but not necessarily for 2016 and 2017. Upward revisions to the latter years would probably raise questions in the markets about an early stop of the programme, something the ECB would like to avoid.

Greece, a multi-polar problem

On June 5, Greece needs to repay the IMF €300M, which will be followed by two more significant repayments during June. Greece probably hasn’t the money and an agreement with its creditors, which would raise €7.2B, is not yet reached. In April the Greek government used already a trick to pay the IMF by drawing the money from its own contribution to the IMF!. It seems that Greece may gain still some time by an obscure rule that would allow the country to pay the three June repayments at once at the end of the month. It is not clear though whether the IMF will allow it. Whatever, it will be interesting how the ECB reacts if Greece misses its IMF payment next week. Will it consider it as a default, in which case it probably has to declare the Greek banking system insolvent and thus no longer eligible for ELA liquidity. It could also decide to raise the haircut on Greek collateral (Greek sovereign bonds) which could also bring the banking system to the brink.

Mr Draghi will probably face significant questioning on Greece but he will likely try to avoid anything remotely like a contentious statement at this delicate stage in negotiations. In that regard, it will be interesting to see whether his responses strike a different chord to statements from some other senior ECB officials that emphasise the binding nature of the rules-based policies to which the ECB must adhere. Clearly, the ECB will act with caution. Greece’s difficulties are first a political problem inside the EMU and EU and second, and key to the approach being adopted by all sides as well as recent US comments, a problem with wide ranging and possibly unpredictable geopolitical ramifications. A failed Greek state in Europe at a time when Russia threatens the Eastern borders of EU and ISIL destabilizes the Middle East and is a threat for the Southern borders. These considerations suggest that the ECB won’t take initiatives that precede a political decision. So, we don’t expect Mario Draghi to provide definitive answers on questions about the prospective ECB reaction to possible non-payment by Greece of monies due to the IMF.