ECB poised for further stimulus?

• ECB President Draghi’s comments raise expectations about Thursday’s ECB meeting.  
• Fed to provide only marginal stimulus, with question of further QE ahead.  
• MPC in wait-and-see mode following recent stimulus measures.  

ECB President Draghi has changed the complexion of the week to come ... The President’s comments yesterday saw financial markets snap into a ‘risk-on’ phase. Draghi warned that it was within the ECB’s mandate to do “whatever it takes to preserve the euro”. More pertinently, he suggested that sovereign debt premia were hampering “the functioning of the monetary policy transmission channels”, an interpretation that opens the way to short-term action. Markets have rallied aggressively in the wake of these comments, Spanish 10-year yields dropped 74bps to 6.85% (below the psychologically important 7% level). Italian yields dropped 50bps, while the euro rallied from lows below $1.21 to $1.23 yesterday (although has since retraced a little) and equities rallied.

ECB posied for more action? ... Previously we assumed no policy changes at this meeting after July’s rate cuts. Yet having raised the prospect of action, failure to deliver over the coming week could result in a sharp reversal. Further rate cuts appear off the agenda for now. Instead expectations centre on a restarting of the Securities Markets Programme (SMP), whereby the ECB buys peripheral sovereign debt. This need not be tied to the Governing Council meeting, although Trichet theatrically unveiled purchases during a press conference around a year ago. The ECB may also hint at further LTROs if it fears the transmission mechanism is compromised. This would have more impact if combined with a loosening of collateral arrangements, as has been muted. But the greatest hopes surround the prospect of a longer-term solution whereby the ESM is given access to ECB funding as hinted at by Nowotny's recent comments. This remains little more than hope at this stage. Yet markets are poised for ECB action and this in itself should help to smooth the passage of next week's Spanish and Italian auctions.

Renewed ECB focus shifts the spotlight from the FOMC announcement...Today’s subdued, but not disastrous US Q2 GDP report, including modest upward recent revisions, failed to make a more pressing case for urgent stimulus at next week’s FOMC meeting. Our global team believes that modest stimulus is likely on Wednesday, with the Fed perhaps pushing its “extended period ” language out to 2015 from end-2014. However, more concerted stimulus and the prospects for further QE depend more on the outlook for growth. The Fed will have seen both the coming week’s ISM and ADP surveys by the time it makes its decision. However, it will not know the full payrolls report until later in the week. Our global team forecasts another subdued 80k headline rise in July, with the unemployment rate remaining unchanged at 8.2%. It believes that this will continue to build the case for a more decisive easing - a restart of QE - in September.

The Bank ofEngland’s MPC meeting should be a lower key affair...Notwithstanding this week’s surprisingly sharp drop in Q2 GDP, the call for further stimulus at this stage is muted by the range of measures the Bank has introduced since last month’s Mansion House speeches. With economic data distorted by one-off effects and the MPC gauging the impact of its stimulus to date, we think, barring a severe economic shock, that the MPC will remain in wait-and-see mode until November when the currrent QE programme expires. Yet, given the distortions to official statistics, it will be even more important than usual to gauge the pace of underlying activity over the intervening period. Our own business barometer, published on Monday, should provide a key insight to this and we will also watch the PMI releases later in the week. We suspect these PMIs will suggest that for now at least, the underlying pace of activity remains subdued, but is not declining further.

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