ECB to try to send clearer message to the markets

Chris Scicluna

Asian equities firmer after soft US core CPI sends Treasury yields lower
With the next FOMC meeting now less than a week away, yesterday’s US CPI report for February provided a timely reminder for policymakers and investors that the economic conditions that would warrant policy tightening are likely some way off. While energy prices lifted the headline index to a 0.4%M/M gain, the core CPI increased a softer-than-expected 0.1%M/M causing annual inflation to moderate to just 1.3%Y/Y. So with core inflation averaging fractionally less than 0.1%M/M over the past five months, earlier selling pressure in the Treasury market was soon reversed, with the 10Y yield ending the day at 1.52%. And with President Biden’s $1.9trn American Rescue Plan expected to be signed into law on Friday, the S&P500 increased 0.6% – with the blue chips in the DJI lifting 1.5% to make a new record high – while the greenback gave back some of its recent gains.

Against that background, it was a mostly positive session for Asian equities today. Sentiment was helped by a further lift in Chinese equities, with the CSI300 up over 2% following yesterday’s late news of stronger-than-expected growth in corporate credit and providing a more positive backdrop for Chinese policymakers as this year’s National People’s Congress drew to a close. Solid gains of 1% or more were also seen on the KOSPI and Hang Seng, with the latter unaffected as China’s NPC approved a resolution setting principles for the future amendment of Hong Kong’s electoral system. In Japan, the TOPIX lagged somewhat with a modest 0.3% advance. But JGB yields moved lower – the 10Y falling 2bps to 0.11% – after Bloomberg reported that the BoJ may look to publish fewer details of its intentions ahead of its rinban operations, which may lead to slightly greater variability in bond yields while keeping the 10Y yield within the current ±0.2% range permitted by the BoJ (which Governor Kuroda is clearly opposed to widening).

In the Antipodes, the ASX200 closed little changed despite a 2.5% rise in Qantas’ stock price after the Government announced it would subsidise 800k half-price domestic airfares for four months from 1 April as part of an A$1.2bn package to try to jump-start tourism, especially with other support measures such as the JobKeeper programme winding down later this month. Assisted by the rally in the US Treasury market, the Aussie 10Y yield fell 6bps to a two-week low of 1.64%.

ECB to try to send clearer message to the markets about reaction function; forecasts for 2022 and 2023 to be little changed
Today’s ECB Governing Council policy meeting announcement provides an opportunity for the policymakers to send a clearer message to investors about the recent bond market sell-off. Despite some differences of opinion, there has also been a good deal of commonality of view expressed by the various Governing Council members over recent weeks (see table of recent comments in our Friday wrap-up). For example, the policymakers recognize the importance of maintaining highly accommodative financial conditions to increase the chances of pushing inflation higher on a sustainable basis. And they acknowledge that relatively low nominal and real sovereign yields will be necessary (if not sufficient) to maintain such accommodative financial conditions. At the same time, recent PEPP purchase data suggest no overwhelming desire to bear down aggressively on yields just yet. Net purchases settled in the week to 5 March, at €11.9bn, were the lowest since 8 January. However, that partly reflected increased redemptions, of €6.3bn, while gross purchases picked up by €1.3bn from the prior week to €18.9bn.

Indeed, the ECB will not be panicking. Despite recent evidence of a tightening of credit standards on bank loans, overall financial conditions remain highly accommodative by historical standards, while the GDP-weighted yield curve remains well below its level before the pandemic struck. The Governing Council will welcome the recent upwards shift in financial market inflation expectations as well as the modest weakening of the euro against the US dollar. And the ECB’s updated economic projections will also suggest that it doesn’t need suddenly to change course with policy even if it still has a long way to go to meet its inflation aim.

Euro area GDP fell less than the Bank expected in Q4. And while a contraction is now highly likely in Q1 (unlike the growth of 0.6%Q/Q forecast by the ECB in December), the GDP outlook ahead might be revised up thanks to the more favourable outlook for external demand. Indeed, we expect only a modest downwards revision to the ECB’s forecast for GDP growth this year (currently 3.9%Y/Y) but a modest upwards revision to the forecast for 2022 (4.2%Y/Y). Most importantly perhaps, while the ECB’s current forecast for inflation this year (1.1%Y/Y) is now clearly far too low, its forecasts for the following two years (1.1%Y/Y and 1.4%Y/Y) appear to merit little revision and a Bloomberg report citing unattributed comments also suggested that those projections will be little changed.

So, policy-wise, we probably should not expect a great deal today. In her press conference, Lagarde will certainly signal that the ECB is mindful of the risks that excessive increases in yields might cause an undesirable and unwarranted tightening of financial conditions, which could ultimately undermine its ability to achieve its inflation target. So, she will likely state that the ECB will monitor financial market developments closely and emphasise a readiness to adjust all policy tools in future if necessary. And she will also likely signal the ECB’s willingness to accelerate purchases under the PEPP programme, albeit within the current envelope, if required to maintain accommodative financial conditions.

Japanese goods PPI rises for third consecutive month with softer yen lifting import prices
On a relatively quiet day for Asian economic data, the BoJ’s producer goods price index increased 0.4%M/M in February – a third consecutive increase. Combined with the impact of base effects, this slowed the pace of annual deflation by 0.8ppts to 0.7%Y/Y, which was in line with market expectations (a small upward revision to January offsetting a small forecast miss in February). The PPI for manufactured goods increased an even more solid 0.5%M/M, reducing annual deflation by 0.9ppts to just 0.2%Y/Y. And with base effects set to be even stronger over the next two months as last year’s slump in commodity prices rolls out of the calculation, annual inflation will rise quickly in coming months to levels approaching 3%Y/Y (especially if the yen maintains its recent softer trend).

The key drivers of the increase in the PPI in February were the same as had driven the solid increases over the prior two months: namely, a further 4.3%M/M increase in the price of energy products (which are now down just 6.3%Y/Y) and a further 3.0%M/M increase in the price of non-ferrous metals (which are now up 18.0%Y/Y). Final good prices increased 0.4%M/M in February, led by a 1.1%M/M increase in prices for imported products. Final consumer goods prices increased 0.6%M/M – also led by higher prices for imports – and so have now increased by around 1% over the past three months. Measured in yen, import prices increased 4.1%M/M in February. So while still down 3.5%Y/Y – not least due to a 16.3%Y/Y fall in petroleum prices – these prices have increased more than 10% since October.

In other Japanese news, reflecting the lagged impact of last year’s decline in corporate profits and perhaps a more persistent change in working habits in light of the pandemic, the office vacancy rate in the Tokyo business area increased a further 0.42ppts to 5.24% in February. The vacancy rate has more than tripled from the pre-pandemic low and now sits at the highest level since April 2015 (which is also close to the long-run average). Not surprisingly, the rising vacancy rate is weighing on office rental rates, which for buildings more than a year old fell for a seventh consecutive month in February – a cumulative decline of 5.5%. So while business spending on plant and equipment may have troughed already, as usual last year’s economic contraction is likely to have a delayed impact on commercial construction.

US data flow unlikely to move markets today
Today’s US economic data is unlikely to give the market much direction, especially with the next FOMC meeting now less than a week away. However, the JOLTS report for January will cast some light on labour market dynamics and so of interest to Fed policymakers as they consider their advice, while the weekly jobless claims report will be of interest too. Meanwhile the Fed will release Flow of Funds data for Q4 which, amongst other things, should report another large lift in household wealth thanks to higher house prices and strong gains in the equity market.

Australian household inflation expectations lift in March
A quiet day for Aussie data saw only the release of the MI measure of consumer inflation expectations. Likely reflecting the visible lift in energy prices, respondents forecast a 4.1%Y/Y lift in the CPI over the next 12 months. While consumers always perceive inflation to be higher than it is in reality, the latest reading is the highest since April last year and also a little above the average reading during the period over which the RBA has been undershooting its inflation target. However, as the RBA has made abundantly clear, a sustained increase in CPI inflation to target-consistent levels is unlikely to emerge until wage inflation increases to at least 3%Y/Y – about double the pace seen last year.

Kiwi house sales up strongly in February as buyers rush to beat new LVR restrictions
In what is likely to be the last strong Kiwi housing report for a while, REINZ reported a 14.6%Y/Y increase in house sales in February as buyers rushed to complete purchases ahead of the re-imposition of loan-to-value (LVR) restrictions on 1 March (which will tighten further on 1 May). Unsurprisingly, that activity was accompanied by substantial pressure on prices, with the median sales price rising a whopping 22.8%Y/Y to a new record high – a sharp contrast with the 10% decline in prices that the RBNZ had forecast at the onset of the pandemic.

Chinese credit growth beats expectations in February
While there were no economic reports released in China today, late yesterday the PBoC released its monthly money and credit aggregates, which should have helped to allay any fears that Chinese policymakers are seeking a sharp tightening of financial conditions. Aggregate financing grew a CNY1.7trn in February – about a third of the pace recorded during the usual beginning-of-year splurge in January. However, this growth was almost double market expectations and a record for a February month. As a result, annual growth in the stock of financing picked up 0.3ppts to 13.3%Y/Y, breaking what had been a 3-month downtrend. That downtrend is certain to resume next month, however, as credit growth is unlikely to be anywhere near the levels seen last year as China emerged from its first lockdown. In the detail, bank lending also increased a stronger-than-expected CNY1.36trn in February, mostly to non-financial corporates. Meanwhile, although growth in M1 slowed to 7.4%Y/Y, growth in the broad M2 measure increased to 10.1%Y/Y.

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