24 hours. That’s the time it took the ECB hawks to break ranks and confirm what most of us suspected – that the ECB Governing Council had discussed a rate hike at the previous day’s meeting. Despite a relatively dovish statement and opening remarks at the post-meeting press conference, the tone turned hawkish as ECB President Draghi was asked if the ECB had considered the possibility of raising the deposit rate before the end of Quantitative Easing (QE). Draghi tried his best to dodge the question, “refusing to speculate” and noting that the forward guidance is “an expectation” and based on “current information”. As we noted in our blog on Thursday, we have seen enough press conferences and speeches from Draghi to know that if he didn’t answer the question, it’s because he wants to keep his options open. And sure enough, on Friday afternoon newswires quoted “people familiar with the matter” as saying that ECB Governing Council members exchanged views on ways of communicating and sequencing an exit from unconventional stimulus. Asking not to be identified because the deliberations were private, ECB officials noted that the Council did not discuss any specific scenario or timeline and hasn’t made any formal decisions on a strategy. We suspect the leak was from the northern faction of the ECB, given that headline inflation is Germany is currently running at 2.2%, and that Bundesbank members have been vocal in calling for a removal of the extraordinary monetary policy stimulus. Remember that Draghi, in March 2016, said “rates are expected to remain at present or lower levels for an extended period of time, and well past the horizon of our net asset purchases”. Given the strong growth and inflation numbers, we think that Draghi will be under increasing pressure from within the ECB to signal the start of rate normalisation and tapering of the ECB’s bond buying programme. Bond yields reacted to Friday’s news by spiking higher, and we expect that trend to continue for the balance of 2017. We continue to like a short duration bias in European sovereign bonds.
2. Dutch Elections
On March 15th, the Dutch electorate go to the polls to vote in their legislative elections. Having consistently lead in the opinion polls, the anti-European Party for Freedom (PVV) have seen their support diminish, with the most recent polls showing the incumbent Prime Minister Mark Rutte’s centre-right People’s Party for Freedom and Democracy (VVD) moving into lead. Led by the flamboyant Geert Wilders, the PVV was founded in 2006 as the successor to Wilders’ one-man party in the Dutch House of Representatives. It won 9 seats in the 2006 general election, making it the fifth-largest party in parliament. By the time of the 2010 general election, its support had grown and it won 24 seats making it the third-largest party. Even when it was leading opinion polls, the other Dutch political parties had signalled their lack of interest in forming any coalitions with the PVV, so it was always unlikely that Wilders would end up in government. But markets will still be watching the results from the Netherlands for a read-across to other European elections, most notably the French national elections at the end of March. Should the anti-EU/Euro and anti-immigration PVV poll better than expected, it could raise fears that Marine Le Pen’s Front National party might also do well in France. Conversely, should the PVV’s support fail to materialise in the Dutch elections, it could signal that European voters are unwillingly to fully embrace the anti-populist mood, thus reducing market fears about a Le Pen victory in France. At the peak of their support, the PVV were predicted to win 30 seats, but recent polls suggest that number could now be as low as 24. Prime Minister Rutte’s VDD are expected to maintain their existing 26 seats, putting them in a strong position to form the next government. Either way, coalition governments are the norm in the Netherlands, given the very fragmented nature of the political system, and some grand centre-right coalition of four or possibly five parties is likely. By its nature, that coalition could take some time to negotiate, but we think markets should be relatively reassured by such an outcome, and therefore are unlikely to show any significant reaction.
3. UK Budget
It wasn’t expected to be a very exciting event, but the UK Spring Budget underwhelmed even the lowest expectations. On the positive side, the Office for Budget Responsibility (OBR) revised up its 2017 GDP forecast by a large 0.6% from 1.4% to 2%, reflecting stronger growth at the end of 2016. Nevertheless, the OBR did note that this stronger growth had reduced the amount of space capacity in the economy, and as a result GDP forecasts for later years were reduced – 2018 falls 0.2% to 1.6%, 2019 falls by 0.4% to 1.7% whilst 2020 is reduced by 0.2% to 1.9%. Possibly the biggest surprise was the downward revision to the 2016-2017 deficit forecast. The deficit could now be £16.4bn lower, compared to pre-Budget expectations of a downward revision of £7bn. The OBR said this largely reflected “one-off factors and timing effects” – in other words, lower borrowing probably will not last. Indeed the 2017-2018 budget deficit is expected to rise again from this year’s deficit of £51.7bn to £58.3bn. UK Chancellor Phillip Hammond is a “Remain” supporter, and he remains concerned that Brexit uncertainty could cause an economic downturn. Hence his decision not to loosen the purse strings and spend the majority of the total downward deficit revision of £29bn – he only spent a net £5bn. From the Gilt market’s point of view, Gilt issuance falls from this year’s £146.5bn to £115.1bn in 2017-2018, slightly higher than the market’s expectations of £109bn. But the split of issuance between short, medium and long-dated issuance is very similar to previous years and in line with market expectations. The Spring Budget is unlikely to have much effect on UK Gilt valuations, but by not “splashing the cash” Chancellor Hammond is building policy credibility ahead of difficult Brexit negotiations.