Draghi expected to leave rates unchanged but does he have a plan B?

Week commencing Monday 5th May 2014

This week in Short

  • In the UK we have Services PMI which should continue to expand in line with expectations, while the BoE are not expected to announce any policy shifts.

  • In Europe we expect little movement from the ECB while French and German industrial production is expected increase marginally on the month. All in all, a reasonably quiet week for the single currency.

  • In the US we expect a marginal narrowing of the trade gap for the month while Janet Yellen is likely to continue to extoll the virtues of tapering to the Joint Economic Committee of Congress. We have the usual unemployment claims data out towards the end of what should be a relatively positive week for the Dollar.   

Overriding Market Themes

It seems that Europe may well be starting to emerge from the woods, after the European Commission raised its growth forecast for the EU, stating that the recovery has taken hold. Real gross domestic product growth in the EU is set to reach 1.6% in 2014 and improve further to 2% in 2015, economists at the European Commission said in their spring forecast. Growth in the euro area is forecast at 1.2% this year and 1.7% next year. In further noble predictions, unemployment rates are expected to decline to 10.1% in the EU and 11.4% in the euro area in 2015. That said, inflation is expected to remain low at 1% in 2014 and 1.5% in 2015 in the EU, and at 0.8% and 1.2%, respectively in the euro region. Previously, the commission projected Eurozone inflation rates of 1.0% in 2014 and 1.3% in 2015. Germany is leading the pack, with the economy expected to grow 1.8% this year. They are followed by a more modest 1.1% from Spain, 1.0% from France and finally a meagre 0.6% from Italy. However considerable risks remains, not least doubts about China's growth prospects and tensions with Russia, which are considerable downside risks to any solid European recovery.

Sticking with Europe and in even better news, Portugal's prime minister has said the country will exit its three-year 78bn euros bailout on 17 May, without needing a standby line of credit. Originally, the Portuguese government negotiated the terms of the bailout package with the troika - the International Monetary Fund (IMF), the European Central Bank (ECB) and the European Commission. In return however, the Portuguese government had to implement tough austerity measures, reduce public debt through spending cuts and eliminate barriers to growth. Additionally, Lisbon had to undertake steps to boost domestic consumption and reduce unemployment. These measures seem to have been successful in turning around the fortunes of the country, with the economy growing by 1.6 % in the final quarter of 2014 (a higher rate than in any other Eurozone member state). They are the third country to attempt a clean break from the bailout package after Ireland and Spain successfully exited last year.

Across the pond, the US economy created 288,000 jobs in April, the strongest monthly job creation since January 2012 and much more than the 218,000 expected by analysts. The report also contained upside revisions for the February and March print totalling 36,000 jobs, pushing the unemployment rate to fall to 6.3%. This is excellent news for Janet Yellen, who has now cut the pace of quantitative easing by almost half and should now remain on track to end the program by the end of this year. This strong jobs number has also caused some to question whether the Fed will be more likely to raise interest rates sooner than expected, causing the greenback to temporarily gain ground against both the Euro and Sterling during Friday’s session. Diving into the release, jobs gains were the strongest in professional and business services, retail, construction and food. Manufacturing also saw a decent upsurge in job opportunities, causing the share of long term unemployed to drop sharply.

Back on British soil, the UK construction PMI showed the sector grew for the 12th month in a row in April, albeit at the slowest rate in six months. Diving into the report, the slowdown in the pace seems to be due to slower business growth in civil-engineering projects after a surge in demand earlier in the year because of flooding. Despite the slowdown, it was welcomed by markets and Sterling quickly saw a boost. It followed the Markit/CIPS UK Manufacturing Purchasing Managers' Index (PMI), which rose in April to 57.3, its highest reading since November. All in all therefore, a good week for Sterling, with the currency finally pushing through the coveted 1.69 level before retreating and consolidating in the mid-to-high 1.68’s. Britain's economy grew 0.8 % quarter-on-quarter in the first three months of the year, and 3.1 % compared with the same period a year ago, its best showing in more than six years.

GBP This Week

We have a relatively quiet week ahead for the UK, with Services PMI, Manufacturing Production and the Bank of England MPC rate decision the only releases of note. We start the week off with Services PMI then, which is expected to be released on Tuesday morning. With the index continuing to post above the critical 50.0 mark, this should be a reasonably Sterling positive event. The market expects the release to come in 0.3 points higher at 57.9, and should we see a print that beats expectations, expect Sterling to once again test those year highs against both the US Dollar and Euro.

We then shift our attention to the Bank of England, where they are expected to leave unchanged its monetary policy in May (Bank rate at 0.5% and asset purchase programme at GBP375bn). Within the minutes they are likely to conclude economic developments over the past month were broadly as expected. GDP growth in Q1 was 3.1% YoY, slightly below BoE’s expectations (3.5% YoY) but might be revised to the upside in the subsequent estimates. We do not expect any significant minutes of note, so we would imagine focus will instead shift onto the May Inflation Report from the bank, which is due to be released on the 14 May.

Finally for the UK we have the Industrial and Manufacturing Production figures, both due to be released on Friday. We expect a modest increase in UK industrial production (0.2%) in March after the strong rebound in February (0.9%). Meanwhile, we expect manufacturing to continue to build momentum, with the market expecting a 0.3% print this month to compliment the 1.0% print we saw in April.

USD This Week

We have a busy week for the US with Fed chairperson Janet Yellen set to testify before the Joint Economic Committee of Congress, in Washington DC. We start however with the ISM Non-Manufacturing PMI, which given the size of the US services sector is crucial to the US economic revival. We expect the indicator to continue to advance, potentially to 54.3 from the 53.1 it posted last month.

Janet Yellen’s then is set to appear in front of the Joint Economic Committee, and will be followed for any shifts in the Fed’s economic and policy outlook following the recent employment figures. It goes without saying that a decent ISM print will make her job easier, and should also remove any doubt that the Fed’s tapering program will continue to cut the level of the bank quantitative easing.

Finally, we forecast the March trade deficit narrowed to USD 39.5bn from USD 42.3bn February. Last month we saw exports plunged 1.1% to USD190.4 billion as sales of commercial aircraft, computers and farm goods fell, while Imports climbed 0.4% to USD232.7 billion on mainly autos and clothing. A narrowing therefore this month, especially now that the weather has returned to normal, should therefore be seems as a risk on event.  

EUR This Week

We have a very light week indeed for the Euro, with all eyes on Mario Draghi’s ECB press conference on Thursday. With the rebound in Eurozone HICP in April (where we saw a jump to 0.7% for the headline and 1.0% fir the core), we expect Draghi to leave policy rates unchanged at its 8 May meeting. That said, we still expect the bank to revise down its inflation estimates and potentially open up a ECB rate cut in June. During the meeting I expect Draghi to repeat that the Governing Council is (unanimously) ready to take more aggressive action if needs be.

We have some industrial production figures from both France and Germany also due to be released, however these should have a limited impact on markets. We expect German industrial production to increase slightly in March to 0.3% MoM (4.5% YoY). French industrial production should remain stable in March (+0.2% YoY, after −0.8% YoY in February).


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