Italian elections and an important European Central Bank could create volatility for the euro, while Brexit talks are sure to impact sterling.
A key election but this does not appear to pose the same kind of risk as was perceived before the constitutional referendum of December 2016.
Italians go to the polls on Sunday (March 4th) with the results expected to be known by early Monday when European markets open. Polls close at 10pm (London time) with exit polls released immediately. Although often quite reliable, in 2013 they suggested much stronger support for the centre-left coalition than actually was the case. A new voting system incorporating dual elements of proportional representation and first-past-the-post makes calling this one harder than in the past.
So far the market reaction has been fairly limited – while the result is uncertain this does not appear to be a binary choice between pro-European and anti-EU parties or candidates as we saw with the French presidential election. Worst-case Eurozone breakup risks are very small ahead of this election but a potential surprise could jolt markets, which do appear rather sanguine. Language around pulling Italy out of the Euro has receded.
Regrettably, the chances of a strong and stable government appear low. While the centre-right coalition appears out in front, forming a majority will be tough. And although the Five Star Movement is in the lead in polls, there is a very limited chance of it seeing power, never mind it forcing a Brexit-type referendum on membership of the Euro or EU. We are in the pre-election blackout for polls so no new data is forthcoming. Importantly, it looks as though a significant portion of voters (about 40%) were undecided at the time of the final poll, which leaves the result even harder to call and could feasibly benefit more energised supporters on the extremes.
Lack of a strong government make economic reforms less likely, which may act as a drag on Italian equities. The FTSE MIB (Italy 40) has significantly outperformed European peers over the last 12 months, rising close to 20%, reflective of the recovery in prices following the deep uncertainty ahead of the December 2016 referendum. As far the euro goes, whilst it has retreated from recent highs as the dollar firms, there does not appear to be significant risk premium attached to the elections, on the basis of options trading.
Ultimately a moderate coalition would be enough to keep the economy on an even keel, albeit without the far-reaching reforms that are required to energise sclerotic productivity.
The European Central Bank meeting on Thursday will be the next key event for the euro. All eyes are on whether the Governing Council is starting to discuss when and how it will bring its quantitative easing programme to an end.
Complicating matters, inflation is refusing to play the ECB’s game. Data last week showed Eurozone inflation slowed to a 14-month low in February, sliding to 1.2% from 1.3% in January. Core inflation, which strips out volatile components such as energy and food, was steady at 1.2%. Most concerning of all, core inflation has barely budged since the ECB launched its QE programme – the measure of underlying price growth has only exceeded 1% five times in the last 24 months.
Speaking last week, ECB chief Mario Draghi warned that “inflation has yet to show more convincing signs of a sustained upward adjustment”, adding that price growth was still dependent on QE. This should keep policymakers cautious for the time being although there may be some discussion around dropping from its communique the so-called ‘easing bias’ – the ECB’s statement of readiness to scale up bond purchases if necessary.
Language may be tweaked to prepare markets – although the lack of decent inflation data may prevent even this.
To signal an end of QE this year, the ECB could leave out any reference to increasing the scale of monthly purchases (but leaving QE open-ended) to signal that it is slowly manoeuvring to guide market expectations. In industry parlance, this would end the asymmetric bias in the QE guidance.
Or it could signal that QE is closed-ended – i.e. the asset purchase programme would come to a halt in September (when the current pace of bond buying is scheduled to finish). This could be done by saying that the current €30bn will continue until the end of September 2018, but dropping the ‘or beyond’ element to signify no intent to extend. This could signal a more rapid taper than is currently expected by markets.
The next phase of talks gets underway after a fairly critical few days in the course of the negotiations. Setting out its first draft on Britain’s exit, the EU pushed for a “common regulatory area” on the island of Ireland if no other solutions are found. British Prime Minister Theresa May responded by saying that “no UK prime minister could ever agree” to this. Sterling slid after the release of the EU’s draft proposal as the stakes are being raised. Rather than converging on key areas, it looks as though there are some lines in the sand being drawn on both sides that neither is prepared to cross. A transition deal is still not a certainty.
The monthly labour market report from the US on Friday will be as closely watched as ever. Headline job creation numbers matter a lot less now that the US economy is, in the words of the Fed, ‘near or a little beyond full employment’.
Instead the focus is on wages. Remember that 2.9% rise in average hourly earnings a month ago? That was the cue for the big market selloff as it signalled inflation is coming, hinting at higher yields and a faster pace of Fed rate hikes. Although the market is adjusting and accepting that inflation is likely to be a little firmer, another strong rise in the average earnings figure could yet hit equity markets again.
A month ago the report showed nonfarm payrolls grew by 200,000 in January, while the unemployment rate stood at 4.1%.
The Bank of Japan policy meeting on March 8th/9th is unlikely to upset the apple cart. Last week the BoJ revealed it is buying fewer ultra-long bonds. This time it didn’t roil markets. It looks as though the markets are getting the message that day-to-day bond purchases don’t matter when you have an explicit yield curve target. BoJ governor Haruhiko Kuroda said last week any normalization would be very gradual and would not take place until inflation targets are hit. Core prices were up just 0.9% in January against a target for 2%.
Meanwhile the Reserve Bank of Australia is also in action this week, again with no change in policy expected. ANZ and NAB have both recently pared back their expectations to one rate hike in 2018 from the two previously forecast as consensus seems to be building around rates remaining at historic lows for longer.
Source: ETX Capital
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