Europe’s economic slowdown makes the proposed normalisation of ECB monetary policy harder

by Franck Dixmier | 23/01/2019
european central bank

Summary

The European Central Bank’s gradual normalisation of its monetary policy should continue, but the economic slowdown in the euro-zone will likely delay any rate increases, and the window of opportunity is becoming increasingly narrow.

Key takeaways

  • At its meeting on 24 January, the ECB should consider the economic slowdown seen in the euro-zone’s four largest economies during the fourth quarter of 2018
  • To avoid a sharp slowdown in financial conditions, the ECB should discuss the possibility of new liquidity programmes targeted to meet the needs of banks
  • In the context of economic slowdown and a possible pause in rate hikes by the Fed, the normalisation of the ECB's monetary policy is becoming more complex

The latest economic developments in the euro-zone make it harder for the European Central Bank (ECB) to continue the gradual normalisation of its monetary policy.

The slowdown has impacted each of the region’s four main economies: Germany, France, Italy and Spain. Each is facing specific difficulties, but all four have seen a synchronised fall in activity indicators, including purchasing managers’ index (PMI) data.

In addition, core inflation, a key indicator for the ECB, is stagnating at around 1% – far from the central bank’s target of below, but close to, 2%.

The ECB will have to take note of these developments. Admittedly, there is no economic forecast due at the 24 January meeting, as the next update is scheduled for March. However, ECB president Mario Draghi should recognise that the slowdown in euro-zone growth, which was seen as temporary in December, will likely last longer than expected. This should be acknowledged even if he remains confident that a recession should be avoided, as he asserted in his speech to the European Parliament in December.

No one doubts the ECB will continue to act to avoid a sharper slowdown in financial conditions. Beyond the horizon of reinvestments announced in December – which could continue after the first rate hike – the central bank could also announce the possibility of new liquidity programmes in 2020. This would calm fears of markets drying up, especially in view of the targeted long-term refinancing operations (TLTROs) repayments.

By maintaining its very large balance sheet (42% of the euro-zone’s GDP), the ECB retains the ability to adopt an accommodative policy despite stopping its asset purchases.

But will the ECB be able to raise rates in the near future? Investors are doubtful, and have pushed their expectations of a first hike in the deposit rate to the second half of 2020. The window of opportunity is becoming increasingly narrow: the ECB can hardly act in a context of economic slowdown, but by waiting too long, it could face other headwinds – the Fed may well lower its rates in 2020, as anticipated by the markets a few days ago.

We are not expecting any significant impact on the market as a result of this ECB meeting, which should only confirm the expectations investors already largely hold.

 



Investing involves risk. The value of an investment and the income from it will fluctuate and investors may not get back the principal invested. Bond prices will normally decline as interest rates rise. The impact may be greater with longer-duration bonds. Past performance is not indicative of future performance. This is a marketing communication. It is for informational purposes only. This document does not constitute investment advice or a recommendation to buy, sell or hold any security and shall not be deemed an offer to sell or a solicitation of an offer to buy any security. 

The views and opinions expressed herein, which are subject to change without notice, are those of the issuer or its affiliated companies at the time of publication. Certain data used are derived from various sources believed to be reliable, but the accuracy or completeness of the data is not guaranteed and no liability is assumed for any direct or consequential losses arising from their use. The duplication, publication, extraction or transmission of the contents, irrespective of the form, is not permitted. This material has not been reviewed by any regulatory authorities. In mainland China, it is used only as supporting material to the offshore investment products offered by commercial banks under the Qualified Domestic Institutional Investors scheme pursuant to applicable rules and regulations. 

This document is being distributed by the following Allianz Global Investors companies: Allianz Global Investors U.S. LLC, an investment adviser registered with the U.S. Securities and Exchange Commission; Allianz Global Investors Distributors LLC, distributor registered with FINRA, is affiliated with Allianz Global Investors U.S. LLC; Allianz Global Investors GmbH, an investment company in Germany, authorized by the German Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin); Allianz Global Investors (Schweiz) AG, licensed by FINMA (www.finma.ch) for distribution and by OAKBV (Oberaufsichtskommission berufliche Vorsorge) for asset management related to occupational pensions in Switzerland; Allianz Global Investors Asia Pacific Ltd., licensed by the Hong Kong Securities and Futures Commission; Allianz Global Investors Singapore Ltd., regulated by the Monetary Authority of Singapore [Company Registration No. 199907169Z]; Allianz Global Investors Japan Co., Ltd., registered in Japan as a Financial Instruments Business Operator [Registered No. The Director of Kanto Local Finance Bureau (Financial Instruments Business Operator), No. 424, Member of Japan Investment Advisers Association and Investment Trust Association, Japan]; and Allianz Global Investors Taiwan Ltd., licensed by Financial Supervisory Commission in Taiwan.
 
 720536

About the author

Franck Dixmier

Franck Dixmier

Global Head of Fixed Income, CIO Fixed Income Europe

Franck Dixmier is Global Head of Fixed Income and Chief Investment Officer (CIO) Fixed Income Europe, and a member of the Global Executive Committee at Allianz Global Investors.

Caution and flexibility: a new “behind the curve” strategy for the Fed

by Franck Dixmier | 24/01/2019
european central bank

Summary

In hitting pause on monetary tightening, the Fed is clearly planning to remain cautious and flexible while staying behind the curve. This offers a favourable context for risk assets in the short term.

Key takeaways

  • Fed Chair Powell's recent statements confirm a change of tone and strategy: the Fed will adopt a cautious and flexible approach to stay “behind the curve”
  • The Fed clearly wants to hit pause on monetary tightening and not increase rates in March – but it is unclear whether this is just temporary or an announced end to rate hikes
  • For investors, this pause from the Fed is an opportunity that offers a favourable context for risk assets in the short term
  • In the medium term, rate hikes cannot be ruled out if inflation overshoots the Fed’s 2% target