ECB plans to maintain its accommodative policy in 2018, positive trends continue in the US

Macro Highlights - 11/2/2017

In short
  • ECB plans to maintain its accommodative policy in 2018, positive trends continue in the US
  • Eurozone focus: Housing markets continue to pick up

Key Takeaways of the week with Sophie Casanova, Economist, Central Banks, Lisa Turk, Economist, United States and François Léonet, Economist, Emerging Markets from the Economic Research Team at Edmond de Rothschild
  • The ECB has announced, in line with our expectations, that it will be continuing with its securities purchases at a rate of EUR 30 billion per month from January to at least September 2018
  • US GDP growth accelerated to 2.3% year-on-year in the third quarter, driven more by the build-up of inventories than by a robust domestic demand
  • The House of Representatives’ vote to approve the proposed 2018 budget – already adopted by the Senate earlier in October – represents one more step towards the implementation of tax cuts

Following its monetary policy meeting, the European Central Bank (ECB) has kept its deposit and refinancing rates at -0.40% and 0.00% respectively, while confirming that it will continue with its asset purchase programme through to the end of 2017 based on EUR 60 billion per month. It also once again confirmed its plans to keep its key rates at their current levels “for an extended period of time, and well past the horizon of the net asset purchases”.

In particular, the ECB indicated, in line with our expectations, its plans to maintain its securities purchases from January to September 2018, and beyond if necessary, at a rhythm of EUR 30 billion per month. In line with our scenario, the tone of its communication was also more accommodative than generally expected. Illustrating this, it declared that it plans to continue reinvesting the amounts it receives when the securities it holds reach maturity “for an extended period of time after the end of its net asset purchases, and in any case for as long as necessary”. This means that even when its asset purchase programme has ended, the size of its securities portfolio is expected to remain constant for the long term. In addition, it did not want to indicate a potential date for ending its securities purchase programme, and Mr Draghi highlighted the fact that the reduction of securities purchases from early 2018 will be a “recalibration” of the programme and not a “tapering”, i.e. a process to gradually scale back the amounts purchased with a view to ending this programme.

Analysis and implications:

  • In line with our expectations, the ECB has confirmed its plans to maintain an accommodative monetary policy in 2018.
  • In line with our scenario, the divergence in monetary policies between the eurozone and US should widen further, since we expect the Federal Reserve to resume its rate hike cycle in December.
  • We are therefore maintaining our scenario for the euro to depreciate slightly against the dollar over the coming months, dropping to $1.12 in the second quarter of 2018.
  • The ECB’s commitment to keeping its key rates at their current level long after the end of its asset purchase programme and the reduction of its monthly securities purchases in 2018 confirm our scenario for the European yield curve to steepen slightly over the coming quarters.
  • We are maintaining our expectations for a 10-year Bund yield of 0.80% in the second quarter of 2018.

In the US, GDP climbed 2.3% year-on-year in the third quarter of 2017, driven primarily by the build-up of inventories, while domestic demand – household consumption and business investment – has been disrupted since Hurricane Harvey struck at the end of August. Consumption growth has continued to cool slightly, down from 2.8% year-on-year for the first six months of 2017 to 2.6% for the third quarter, despite the savings rate dropping from 4.1% of disposable income in February to just 3.6% in August. Non-residential fixed investments’ growth has remained stable, indicating year-on-year growth of 4.4%. While investment in equipment has continued to accelerate, growth in structures spending has slowed down. Hurricane Harvey may have held back certain construction projects for buildings and factories. Alongside this, the number of operational oil rigs has fallen slightly since early July, with the energy sector’s quarterly investment growth contracting from 21% in the second quarter to 5% in the third quarter. The slight upturn in domestic demand expected in response to Hurricane Harvey over the coming months – linked primarily to reconstruction efforts – should make it possible to reduce the stock levels built up. Lastly, the balance of trade was less negative than in the second quarter, particularly following a slight drop in imports. However, the dollar’s depreciation by 5.75% since the start of the year has enabled US exporters to increase their export volumes by 0.6% quarter-on-quarter. 

These positive developments have been accompanied by the House of Representatives’ approval of the resolution for the 2018 budget, previously adopted by the Senate on 19 October. This budget proposal offers support for the new tax measures that the Trump administration is looking to put in place, for several reasons: on the one hand, the budget includes the famous “reconciliation” procedure allowing the tax cuts to be adopted with a simple majority in the Senate. In theory, this means that the 52 Republican senators would not require any backing from the Democrats. On the other hand, the budget includes a drop in revenues by USD 1,600 billion from 2018 to 2027, reflecting the introduction of the tax cuts. It also includes plans for a USD 4,800 billion reduction in spending, which should notably make it possible to achieve a fiscal surplus by 2026.

In China, the 19th Communist Party Congress ended with a strengthening of Xi Jinping’s powers, with his leadership following on from Mao Zedong and Deng Xiaoping. The Politburo Standing Committee’s new members do not include any designated successors, opening up the possibility for a third term for Xi Jinping in 2022. The State is therefore expected to continue to play a major role within the Chinese economy.

Sophie Casanova, Economist, Central Banks, Lisa Turk, Economist, United States and François Léonet, Economist, Emerging Markets


Eurozone focus: Housing markets continue to pick up

  • Housing prices have continued to climb in the eurozone and construction activity has accelerated in 2017
  • This price growth should continue, although without any significant acceleration due, in particular, to the gradual increase in rates and the construction sector’s continued recovery

The recovery in the eurozone’s real estate markets is now being driven by 17 of its 19 member countries, with prices continuing to fall in just Italy and Greece. Overall, property prices have climbed back above their pre-crisis levels and are up 9.6% from their 2013 low. Price growth has been particularly dynamic for the past few quarters and, while it slowed down very slightly at the start of 2017 (see left-hand chart), this was primarily due to the German property market. The slowdown in prices seen in Germany reflects certain specific factors, including a sharp drop in the number of asylum seekers arriving in the country – 645,000 from January to September 2016, compared with just 137,000 for the same period in 2017 – and the particularly strict application of the European Union mortgage credit directive that lead to tighter lending conditions. Germany’s specific case does therefore not point to any marked slowdown in price growth for the eurozone’s other countries. Alongside this, while prices look set to continue rising at a sustained rate, no significant acceleration is expected, particularly with the gradual increase in rates and the construction sector’s recovery.

Housing prices have continued to rise

In line with our expectations, growth in eurozone real estate prices has picked up in the past few quarters, up from 3.4% in 2016 to 3.8% for the first half of 2017, the highest rate of growth seen since 2007. This acceleration reflects several factors, confirming our scenario for prices to continue rising at a sustained pace over the coming quarters.

  • The ECB’s accommodative monetary policy has contributed to bringing mortgage rates down and keeping them very low, while banks have introduced more flexible lending conditions. While the slight upturn in eurozone sovereign yields since the second half of 2016 has pushed up mortgage rates slightly, they are still very low (see right-hand chart, p.4). The average cost of a new home loan was 1.9% in August 2017 in the Eurozone. At the same time, banks have continued to roll out more flexible lending conditions according to the Eurosystem bank lending surveys. As a result, aggregate new mortgage lending reached nearly one thousand billion euros between May 2016 and May 2017, an all-time high, driven by households looking to benefit from the low rates available.
  • Household solvency levels have continued to improve in the past few quarters. The households’ deleveraging that occurred between 2012 and 2014 and then the low level of interest rates, against a backdrop of an economic recovery, have led to a widespread reduction in the debt servicing burden. In Spain for instance, mortgage repayments – capital and interest – represented 7.3% of household income one year ago, compared with just 6.8% today. Alongside this, conditions on the job markets are continuing to improve. Unemployment fell from 10.1% to 9.1% between the month of August 2016 and 2017 in the eurozone. In addition to increasing disposable income levels, the drop in unemployment is reducing the probability of people being out of work, encouraging households to invest more in a home. 
  • Despite a slight drop in the risk premium1 for housing, it is still a particularly attractive investment. With on the one hand, the increase in 10-year sovereign rates, and on the other hand, prices rising more quickly than rent, investment in property has lost some of its appeal. However, despite falling, the risk premium is still very high from a historical perspective. In the case of France for instance, the risk premium was 4.1% in the second quarter of 2017, down 0.8 percentage points from the last quarter of 2016. Nevertheless, this premium is still far higher than its average of 2.4% since 1996, which means that housing is still a relatively attractive investment.

While this growth in prices should continue, it should not experience a sharp acceleration.

Several factors could rein in price growth over the coming quarters and prevent any sharp acceleration.

  • We expect to see long-term bond yields gradually rise, which could push up the cost of borrowing. This could lead to higher mortgage rates, particularly for maturities over 10 years (56% of new mortgages in the first half of 2017). Growth in mortgage borrowing could therefore slow down. This trend has already been indicated by the ECB’s latest bank surveys, which show that they expect growth in demand for credit to buy homes to gradually slow down.
  • The recovery in prices has also encouraged an upturn in the number of properties built since the end of 2015, which is increasing supply and therefore weighing on price growth. Construction activity levels have been particularly robust for the past few quarters (see right-hand chart). In the second quarter of 2017, the value-added generated by the construction sector increased by 3.6% year-on-year, its highest rate for over 10 years and nearly three times higher than for the same period in 2016. This trend is reflected in an increase in housing starts: in France, they climbed to 411,300 for the 12 months to August 2017, up 14% from 2016.

The improvement in housing markets should continue to drive growth

While it is expected to slow down over the coming years, the eurozone’s positive property price growth looks set to continue, helping drive the construction sector’s continued recovery. Illustrating the upturn in activity and confidence among construction firms, this sector’s employment figures have increased significantly in 2017, returning to the levels seen in 2012, after having seen a further drop in 2016. This is good news for a sector which, with 9.2 million workers, still employs 19% fewer people than in 2007. After contributing 0.2 percentage points to GDP growth in 2016, housing construction and renovation have continued to increase and, based on our forecasts, are expected to contribute 0.3 percentage points to growth in 2017.

[1] This indicator is calculated as: 

  -   risk free rate.

It measures the difference in return between an investment in real estate and a risk-free investment.

Photo : "Governing Council Press Conference" by European Central Bank licensed under CC BY-NC-ND 2.0