Germany ups its borrowing as ECB poised to up its bond purchases

Emily Nicol
Chris Scicluna

With little in terms of substantive macroeconomic news from the region to excite investors, but US-China tensions and US social unrest continuing to dominate attention, Asian stock markets today were somewhat less ebullient than of late. However, with reports of political agreement on a new German fiscal stimulus package providing some good news (see detail below), most of the major bourses were still able to chalk up modest gains (e.g. the Topix closed up 0.3%). However, China’s stock markets ended the day very marginally lower while US stock futures fell, European equities have opened lower, and the dollar was a touch firmer too.

In the bond markets, however, following yesterday’s upwards shift in UST yields, JGBs made notable losses except at the short end, and demand at today’s 30Y auction was the weakest in almost four years. ACGBs also played catch up and so dropped today, with 10Y yields rising 5bps to move above 1.00% for the first time since March despite confirmation of a record drop in Aussie retail sales. Meanwhile, ahead of today’s ECB announcement, which is expected to bring with it confirmation of an expansion in the PEPP asset purchase programme, euro area govvies are showing a mix of modest gains and losses, with Bunds currently marginally firmer despite the prospect of a further significant increase in issuance.

Compared to the other large European countries, Germany has had a relatively ‘good’ pandemic, with significantly fewer deaths per capita and economic activity rather more resilient. And while unemployment is set to rise further, and GDP will fall more than 6% this year, the new German fiscal stimulus package agreed last night represents a welcome potential source of upside risk to demand.

Following the initial federal government supplementary budget of €156bn, the new fiscal package has a price tag of €130bn (close to 4% of annual national GDP) to be spread largely over the remainder of this year and next, with the vast majority (€120bn) to come from the federal government. Key measures include:

  • A temporary 3ppt cut in the main rate of VAT to 16% (which will apply to sales of cars among other items), and a 2ppt cut in the reduced rate to 5% (applying to items such as food), to be in place throughout the second half of this year.
  • An increase in the government purchase incentives for electric and hybrid cars for cars costing up to €40k, and support to build charging stations and support battery cell production.
  • A cut in the renewable energy surcharge to reduce electricity bills in 2021 and 2022.
  • A one-off “children’s bonus” of €300 per child to be paid to parents, as well as support for childcare, kindergartens and schools.
  • With unemployment set to continue to rise, extra government support for the social security system to prevent a rise in employer and employee contributions.
  • Support for cultural and non-profit organisations, and municipalities.
  • New business tax reliefs, and carry-over of unused support for SMEs from the first support package.

All eyes today will be on the ECB meeting, with a widespread expectation that the Governing Council will agree an increase in asset purchases. The precise amount and timeframe of the extra purchases is highly uncertain. But, in line with the consensus, we expect the PEPP total to be increased by a further €500bn, with the programme extended into 2021, perhaps as far as September 2021 to match the timescale of the recent changes to collateral rules. Of course, with expectations of extra purchases now fairly hard-baked, a failure of the Governing Council to rise to the occasion today would likely trigger renewed volatility, particularly for BTPs.

On top of the simple announcement of an increase in the PEPP target, the ECB might also announce several further measures today to enhance its stimulus. Among other things, we suspect that it will announce that the principal payments from maturing PEPP bonds will be reinvested for an extended period. In light of the European Commission's proposal to issue €750bn of bonds to fund recovery, the ECB might also signal its readiness to increase the share of the PEPP programme taken by supra-national bonds – figures published on Tuesday suggested that so far such bonds had accounted for 6% of PEPP purchases. The Governing Council could also hint at a willingness to buy bonds of fallen angels within the context of its corporate bond purchase programme. And with excess liquidity having risen by some €500bn since end-February to close to €2.2trn, the Governing Council could also increase its tiering multiplier to exempt a larger share of banks’ excess reserves held at the central bank from the negative policy rate.

The justification for increasing and extending the PEPP programme further will be provided by the ECB’s latest set of staff forecasts. Following the April Governing Council meeting, the ECB published three illustrative scenarios, whereby GDP would drop by around 5%, 8% and 12% respectively under the “mild”, “medium” and “severe” assumptions. The account of that meeting, however, suggested that even then the Governing Council members judged the “mild” scenario to be unrealistic. And, according to recent comments by ECB President Christine Lagarde, the ECB’s updated forecast is likely to show a path for output somewhere between the “medium” and the “severe” scenario, which would also be broadly in line with our own baseline projection. Even assuming no second wave of pandemic and lockdowns, it would also imply that GDP would not be expected to return to the pre-pandemic level before end-2022 or beyond. Of course, the German stimulus package will be judged to represent a source of upside risk to that outlook. But there’s no shortage of downside risks out there too.

Euro area economic data:
Datawise, today sees the release of euro area retail sales data for April. The national spending figures have added to evidence that Germany’s retailers have weathered the pandemic storm far better than the other large member states, albeit with sales down 5.3%M/M in April. In contrast, French household consumption on goods and Spanish retail sales fell by more than 20%M/M in April, the most on record. Consequently, euro area retail sales are forecast to have fallen 15%M/M in April (and 20.6%Y/Y), as the lockdowns imposed across the region significantly impacted spending on non-essentials. Construction PMIs for May from members states, also due to be published, will provide further evidence that the economic weakness remains broad-based.

While the construction and manufacturing sectors were encouraged back to work in the middle of last month, much of the country, including non-essential retailers, remained under strict lockdown measures. So, while some car dealerships offered a click and collect or home delivery service, showrooms remained closed throughout May. As a result, UK new car registrations are bound to have remained extremely weak – indeed, reports suggest that registrations (official statistics from the SMMT will be published at 9am) were down almost 90%Y/Y last month following a drop of 97.3%Y/Y in April. This by far exceeds the pace of decline seen in equivalent releases from France (-50.3%), Italy (-49.6%) and Spain (-72.7%) earlier this week. And over the first five months of the year, this would leave UK car sales down more than 50% compared with the equivalent period in 2019 at around 500k units, the lowest year-to-date number for the month of May since 1971.

Like in the euro area, this morning will also see the release of the UK construction PMI for May. This is expected to reveal a sharp moderation in the pace of decline, with the headline index forecast to rise to 29.4, from 8.2 in April as construction workers returned to work, albeit under social distancing rules.

There were no major surprises from today’s final Aussie retail sales and trade figures for April, which were significantly impacted by the Covid-19 crisis and associated lockdown measures. In particular, retail sales fell a record-17.7%M/M (compared with the initial estimate of -17.9%M/M), more than fully reversing the near-6%M/M jump in March. This left sales down more than 9% compared with a year earlier, the first annual drop since the series began in the early 1990s. The detail confirmed sharp declines in clothing and footwear (-54%M/M) and department store retailing (-15%M/M) despite a pickup in online sales. Meanwhile, restaurant and takeaway services remained extremely weak as the lockdown forced closures. And the decline in spending on food was almost double the panic-buying related surge (9.2%M/M) seen in March. While lockdown measures started to ease through May, if yesterday’s car sales figures are anything to go by (-35%Y/Y), demand is highly likely to have remained subdued.

Meanwhile, the trade surplus narrowed to A$8.8bn in April from a record A$10.4bn in March as the 11.3%M/M drop in the value of exports more than offset the near-10%M/M decline in imports. The weakness in goods exports was driven by a pullback in shipments in commodities following a surge in March, while exports of services also declined sharply for the fifth consecutive month, as travel restrictions continued to be enforced. This was also true of services imports, which were down a massive 42½%M/M in April, with travel services imports down 98%M/M.

In the US, ahead of tomorrow’s payrolls report, the usual weekly initial claims figures will be published, alongside Challenger jobs cuts numbers for May, trade figures for April and final productivity and labour costs data for Q1.

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