Euro Macro: More weakness moving into Q3 – The eurozone PMIs for July were published today. The modest gains in the composite PMI that were registered in May and June were completely erased, with the index declining from 52.2 in June to 51.5 in July. This decline was the combined result of a drop in the manufacturing activity PMI (from 48.5 to 47.0 – the lowest level since April 2013) and a more moderate decline in the services sector activity index (from 53.6 to 53.3). At its current level, the PMI is consistent with eurozone GDP growing by just 0.0-0.1% qoq, which would be in line with our base scenario for the eurozone. Indeed, the forward looking parts of the PMI report also suggest that the economy will be close to stagnation, with the new exports orders component of the manufacturing PMI falling by almost three points in July to its lowest level since June 2012. On top of that the new business component of the services PMI declined by a full point, suggesting that activity in the services sector is being affected by the ongoing malaise in industry. The fact that the services sector is not immune to the weakness in industry was also illustrated before by a drop in Germany’s Ifo business climate in services and the ECB’s Bank Lending Survey that was published yesterday.
Other details of the PMI report suggest that the weakness in the eurozone economy, which began in exports and the manufacturing sector around the start of 2018 has spread to the labour market. Indeed, the employment component of the composite PMI lost a full point in July to a level consistent with only moderate employment growth. We think the deterioration in labour market conditions has further to go as the eurozone labour market reacts to changes in economic growth with a relatively long delay. This should result in the unemployment rate starting to move slowly higher at around the end of this year. Overall, the PMI reports support the case for an ECB stimulus package. We previewed tomorrow’s Governing Council meeting and set out our base case for the ECB in Monday’s Global Daily Insight. (Aline Schuiling)
Euro Financials: ECB unlikely to change its view on unsecured bank bonds – With a restart of ECB net asset purchases likely before long, speculation has built that the central bank will include unsecured bank bonds as part of its asset purchase programme. We doubt it will do so and instead think it will stick to the assets it has bought up until now (but with a bigger skew than before towards corporates, national agencies and regional government bonds – see our note on the composition of APP-II below). Why are unsecured bank bond purchases unlikely? Firstly, if it did buy these securities, the ECB’s independence could be called into question. The ECB (together with related institutions) is the bank regulator and it would cause a clear conflict of interest if the ECB bought unsecured bank securities. For instance, the ECB could be reluctant to put a bank into resolution as it could take losses in a bail-in. Secondly, the ECB does not need to directly buy bank bonds for them to benefit. Spreads on unsecured bank bonds are correlated with those on corporate bonds. As the credit market moves in a similar way, a purchase of one sector directly benefits another as the investor base hunts for relative yield. The close relationship across credit sectors even during purchase programmes is strong. For instance, the Utilities index (a solid non-cyclical sector) and Bank index spread levels are within basis points of each other and move in tandem (with monthly correlation at 0.73). Finally, we think the ECB can execute a large programme using existing asset classes.
By Aline Schuiling,Tom Kinmonth
PUBLICATION,
Source: ABN AMRO