Don’t read after dark!

As expected, the ECB did not engage in any meaningful forward guidance beyond the rate cut it provided last week. We consider that keeping the list and characterisation of the downside risks to growth and upside risks to inflation largely unchanged relative to July could be easily challenged given the dataflow over the summer. This “steady boat” approach reflects in our view a difficulty to bridge disagreements across the Governing Council. In these circumstances, we are surprised to see that the market is still pricing 11-bps worth of a cut in October. We stick to our guns and do not expect this before December. True, if the dataflow turns even more concerning – a distinct possibility in our view – the hawks at the Governing Council may have to “capitulate”, taking the ECB to a more decisive path. Yet, it seems to us that, as much as we think that, indeed, a clearer easing outlook is now warranted, the bar to get there remains high.

While the European short-term outlook does not look very promising, the same can be said about the long-term prospects according to the Draghi report released last week. This is not a reading for the faint-hearted – and not just because it stretches along 400 pages of compact macro. His point about the risk of a “slow death” of the EU is clearly intended as a wake-up call, but the report may add to a sense of helplessness by drawing attention to Europe’s difficulties with swift decision-making. The policy recommendations themselves make a lot of sense, but Europeans have known for a long time what needs to be done. The key issue is political appetite at the national level. In our view, the “European machinery” aspects are secondary.

While Europeans look to the US economic performance with envy, locally the focus of the policy debate is squarely on how to mitigate an impending slowdown. The market is hesitating between pricing 25 or 50 bps for this Wednesday’s cut by the Fed. We still maintain our view the Fed will choose 25, even if it is close.