Economic Developments Still Soft, but No Room for Further Downward Revisions
Having terminated net asset purchases in December, the ECB adopted more dovish policy rhetoric early this year. The Bank has highlighted weaker-than-expected economic data due to slower global demand and the persistence of country- and sector-specific factors. However, somewhat in contrast to this, Eurozone Q1 GDP actually registered a fairly firm 0.4% q/q expansion. Domestic demand was also somewhat resilient, particularly in Germany and France, which should offer some comfort amid lingering global uncertainty. The firm Q1 growth number will likely also prevent the ECB from lowering its 1.1% GDP forecast for 2019 any further. Instead, there may be a small revision higher to the 1.2% we expect for 2019, though base effects could lower the 2020 forecast marginally from the 1.6% the Bank expected in March.
More importantly, the ECB has also become visibly more worried that it will not meet its inflation remit. In March it lowered not only headline inflation forecasts, but also the core inflation projections over 2019-21. This loss of confidence, accentuated by the continued, if not deeper, weakness in the various inflation expectations it tracks, comes as growth is only slightly below trend while the strong labor market experienced in recent years has so far failed to produce meaningful pickups in core inflation. However, given the substantial revision in March, which pointed to HICP inflation of still only 1.6% at end-2021, we expect the ECB to make no further changes.
TLTRO-III Needs Some Details
The June meeting will also be closely monitored for any further details regarding TLTRO-III, which will be carried out on a quarterly basis between September 2019 and March 2021. In particular, it would be interesting to see whether the new loans will be considered an active policy tool or if the operations are meant to be used as a liquidity backstop to overcome potential refinancing hurdles (Figure 1).
If the ECB were to provide funds at the refi rate prevailing at allotment or at a higher fixed rate without any incentive to increase take-ups, the new program would be interpreted as a liquidity back-stop. Indeed, this could still be seen as supportive for certain lenders or even peripheral issuers, but its relevance as a policy tool would be low.
Alternatively, the new program could be designed to allow banks to switch existing funding from the older TLTRO-II to the new TLTRO-III, with a pricing mechanism similar to that of the TLTRO-II, which introduces incentives aimed at offsetting the added cost of the new liquidity injections from the negative deposit rate. In this case, the TLTRO-III could be seen as a sign of a more active policy instrument aimed at consolidating or expanding its supply of credit.
Deposit Rate Will Be Unchanged Until Q1 2020, Tiered Rates Unlikely
While more details are desperately sought by markets, we doubt that the ECB will reveal too much that would risk undermining its existing forward guidance on interest rates, which currently signal that rates will “remain at present levels at least through the end of 2019.” We are very much of the view that there will no resuscitation of the formal easing bias last seen in mid-2017, despite markets having started to lean in that direction. Given this expected unchanged guidance, we expect to see the first interest rate hike of 10 bps on the deposit rate only in late Q1 2020. This will be followed by other two 15-bp rate hikes, one in Q3 2020 and one in Q1 2021. The main refinancing operation rate is meanwhile expected to stay at zero until Q3 2020, when we expect it to be hiked by 10 bps, with a further rate hike of 15 bps set to occur in Q1 2021. But given the weakness in the global economy the risk is also that such moves may occur somewhat later.
ECB President Mario Draghi is likely to be quizzed on the effect of negative interest rates on bank profitability and if the introduction of mitigating measures, such as tiered deposit rates, are warranted. In this regard, it is likely that the ECB will continue to stress that cost efficiency, excess capacity and the need for consolidation were the main factors hampering profitability.