Markets have once again started pricing in some risk of a rate cut and many analysts changed their view after last week’s numbers. A majority of analysts now expect a refi rate cut from the ECB already at the meeting this week. We stick to our call and find it most likely that the ECB will keep rates on hold and instead come up with new measures to support bank lending to Small and Medium-sized Enterprises (SMEs).
A disappointment on the cards?
We basically see three possibilities for the ECB on interest rates this week. Either the ECB cuts its refi rate, the ECB sends a clear signal of a refi rate cut in June or the ECB remains dovish but without giving clear signals of an upcoming rate cut. We favour the last, but realise that we hold a minority view. A refi rate cut would probably require that the ECB believes the economic outlook has deteriorated again or that the ECB is unable to come up with anything new to support SMEs.
Expectations for more action from the ECB have been building ahead of the meeting. This has been evident especially in equity markets where weak data releases have been disregarded in the hope that the ECB would provide more stimulus. In light of such expectations and our baseline view, risks are clearly tilted towards a disappointment. Such a disappointment would most likely be illustrated foremost on the equity markets in the form of falling prices, while bonds could actually gain on the back of weaker risk appetite and expectations that the ECB was falling (further) behind the curve. Short rates would most likely see smaller moves or could even rise a bit and the curve would thus bull flatten. As bonds would most likely do relatively well also in a scenario, where the ECB did provide more stimulus, being long bonds ahead of the meeting looks like a good strategy, despite the expensive levels.
SME support could consist of a combination of easier collateral requirements on SME loans, ie reduced haircuts and accepting lower rated loan portfolios, and some measures to support the ABS market.
A bit of background
Several ECB officials have spoken in recent weeks. The general message seems to be 1) that the ECB is ready to act on rates if the economic outlook continues to weaken, but that more information is needed, 2) that the effect of a refi rate cut would be limited and 3) that the ECB is still thinking about how to support bank lending to SMEs. The ECB is leaving all options open. Key figures have remained weak. Euro-area flash composite PMIs were actually unchanged compared with a month earlier and in line with expectations. Weakness shifted from France in March to Germany in April. The Ifo index gave the same bleak outlook for the German economy as the German PMIs. The ECB’s lending survey showed a more or less unchanged picture in Q2, ie limited supply constraints and weak loan demand. Inflation has fallen clearly below 2% and will continue falling in the near term. This was in line with the ECB’s projection, though, and is due by and large to falling energy prices. Falling energy prices is good news for the economy and could actually be slightly inflationary in the medium term. Still, the ECB has previously reacted to changes in energy prices.
Nordea