Markets:

The ECB changed its forward guidance on the asset purchase program and on interest rates today. The former was widely anticipated, the latter came as a surprise. The monthly pace of asset purchases will drop from €30bn/month to €15bn/month in Q4 2018 after which net asset purchases will end. Progress on inflation has been substantial and the ECB grew confident that inflation convergence towards the 2% aim will be sustained, warranting the tapering of QE. However, an ample degree of monetary policy needs to remain in place to support a further build-up of domestic price pressure. The ECB’s reinvestment policy of maturing bonds from its asset portfolio therefore remains in place for the foreseeable future. The communication on interest rates changed from “remain at current levels for an extended period of time after ending net asset purchases” to “remain at present levels at least through the summer of 2019”. The ECB basically mapped out monetary policy for the next 15 months, suggesting a first rate hike in September 2019. That’s 3 months later than our previous June forecast. We think that this cautious approach is inspired by the growth moderation in Q1, coming from high levels and as the ECB doesn’t want to underplay existing risks to the outlook (trade, protectionism, higher volatility, supply constraints…). Officially, risks to the eco outlook remain broadly balanced. Growth forecasts remained unchanged for 2019 (1.9%) and 2020 (1.7%) for now, but this year’s projection decreased from 2.4% to 2.1%. Inflation forecasts faced an upward revision from 1.4% to 1.7%, both in 2018 and 2019, while the 2020 projection was unchanged at 1.7. Uncertainty over the inflation outlook is receding.

Both European/German interest rates and the euro trended higher ahead of the ECB decision. Investors positioned for the ECB announcing a reduction in policy stimulus. The ECB effectively announced a two-step phasing out of APP, but also committed to keep rates unchanged at least till September 2019. In a first reaction, yields were inclined to rise. EUR/USD briefly jumped to the mid 1.18 area. However, markets soon realized that the new guidance on interest rates ‘guaranteed’ extremely low (official) EMU interest rates at least for the next 15 months. The monetary policy horizon in EMU is more or less cleared for ‘an extended period of time’. German bond yields turned back south. Yields decline between -2.5 bps (30-y) and -3.5 bps (5 y). Intra-EMU-spreads widened substantially in the run-up to the ECB decision, but narrowed sharply after the announcement. The 10-yr yield spread between Italy and Germany is little changed (+3 bps). The euro also made an impressive U-turn. EUR/USD reversed the initial spike higher and the euro decline accelerated throughout the press conference. Draghi indicating that the ECB didn’t underestimate risks (both on the economy and with respect to global uncertainty) probably added to the euro decline. EUR/USD trades currently in the 1.1680 area. US retail sales also printed very strong (0.9% M/M) during the press conference. The report reinforced the slight underperformance of US Treasuries versus Bunds. US yields decline by 0.8 bps (2-y) to 2.0 bps (10-y). Strong US data were also slightly supportive for the dollar. USD/JPY rebounded off the intraday low just below 110 and trades currently again in the 110.35 area. In a more global perspective, yesterday’s Fed decision/trajectory and today’s ECB communication might reduce market volatility again as uncertainty on monetary policy has been reduced sharply.

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Brexit moved a bit to the background today as a driver for sterling trading. Attention turned to the May UK retail sales. After a rebound in April, May sales were again strong. Temporary factors (sales related to the Royal wedding, better weather) were at least partially in play. Even so, the report suggests that Q2 growth might be less weak than feared. On the other hand, it is far from sure that this improvement will be enough for the BoE to already fully play the card of an August rate hike. The market implied probability for an August hike hovers around 50%. The gain of sterling after the retail sales report was modest. EUR/GBP dropped temporary below 0.88, but sterling momentum remained sluggish. The post-ECB setback of the euro also weighed on EUR/GBP later in the session. The pair trades currently again in the 0.8775 area. USD strength pushed cable back to the 1.3325 area.

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