Economics and Strategy
European Outlook – QExit and Brexit: Mario and Mark’s Adventure Is about to Get Bumpy
— David Owen, Chief European Financial Economist
— Marchel Alexandrovich, European Financial Economist
With the ECB preparing to end QE, the BoE eyeing further rate rises and the US Fed on a path of rate normalisation, the decade of extraordinary monetary policy is coming to an end. The direction of travel is clear, but the timing of central bank policy steps is anything but certain. Will the strength of the recovery allow the ECB to forego tapering altogether? Will the BoE be in a position to raise interest rates if the UK is seen to be aimlessly drifting out of the EU? And would the Fed follow through on multiple rate hikes next year, even if inflation continued to undershoot expectations? These are likely to be some of the main points of debate in 2018.
Inflation, in a familiar way, remains the missing piece of the puzzle. After years of disappointment, few are forecasting anything other than subdued growth in wages and prices for the year ahead. But if inflation were to surprise on the upside, market interest rates could surge higher, with the Central Bankers playing catch up.
The ECB, will take its time winding down QE, but the pace of its sovereign bond purchases could fall by more than half from the start of the year, with all eyes on what happens to periphery spreads in the aftermath. Globally too, with almost 50% of ECB QE purchases made from foreign investors and recycled into overseas assets, a less active ECB will impact the US and the UK markets.
The Catalan issue remains unresolved, but generally, the political obstacles of 2017 were navigated without major damage; now the focus is on the upcoming Italian election on 4 March. The 5 Star Movement lacks an obvious route to power, but substantial market volatility still seems likely around the event. At the ECB, all eyes will be on the departure of Vitor Constancio - Draghi’s dovish vice president - at the end of May. A hawkish replacement (perhaps Knot) could signal an important shift at the heart of the institution.
In the UK, the clock is ticking down to the March 2019 Brexit departure date, while the BoE is essentially trying to guess what the new set-up will mean for the long-term prospects for the economy. The February BoE Inflation Report should help guide interest rate expectations for the rest of the year & the markets may once again be caught out by the MPC’s hawkish leanings. Politically, the lull during the EU/UK trade negotiations in the first half of the year could be followed by a frantic sprint for the finish line in the final months of 2018, as the provisionally agreed Brexit terms are scrutinised for final approval. Indeed, if the MPs are given a ‘meaningful vote’ on the final deal, the government’s slim majority could be severely tested in passing the final legislature through, raising the prospect of a new General Election a & the possibility of Article 50 being extended to buy all sides more time. FULL REPORT