Week in Review (7 June)

Draghi adopts dovish tone after changes to forward guidance

The latest ECB staff projections, published in conjunction with the 6 June Governing Council (GC) meeting, further downgraded the medium-term outlook for the European economy – although with a minor upgrade for the short term.

As we noted in our preview of the GC meeting, downgrades to the economic projections inevitably raise questions from market participants about how the ECB will respond. In this case, Draghi and the GC opted to act immediately by changing the forward guidance on rates, which now foresees no action through the first half of 2020.

This change brings the guidance into line with what market expectations had been indicating for months. In his post meeting press conference Draghi was questioned on the fact that market expectations are now shifting toward the next move on rates being a cut. In responding to this, Draghi left himself – and more likely his successor – flexibility, stating that there were varying opinions in the GC as to the appropriate course of action, including rate cuts and the reopening of sovereign bond purchases.

Our reading of the meeting is that Draghi was essentially seeking to reiterate that, if necessary – due for example to a deterioration in the economy, the ECB will act. Draghi also denied that there is a hiking bias in the ECB’s forward guidance, answering ‘no’ when asked if it was correct that the next move in interest rates is more likely to be an increase than a cut. In the event that a cut is required, Draghi said that ‘mitigating measures’ i.e. tiering, could be put in place.

German coalition creaks amid pressure on SPD

Germany’s grand coalition of the CDU/CSU and SPD has come under further strain following the European elections, which delivered poor results for both parties. The SPD recorded only 15.8% of the vote, while the CDU/CSU dipped below 30%.

Faced with such a poor result, SPD leader Andrea Nahles tendered her resignation, little over a year since she took up the position. The party is now under caretaker leadership, and is likely to remain so on 24 June, when the party will review its coalition agreement with the CDU. This review has raised fears that the coalition could crumble, possibly forcing snap elections.

A snap election before the end of the year may become unavoidable if the SPD performs poorly in state elections due to be held in Saxony and Brandenburg on 1 September. The public mood has also shifted towards snap elections – opinion polling suggests that some 65% of decided voters want to go to the polls.

We understand that CDU figures in Brussels are pushing for collaboration between the EPP and Green groups at European level. This is intended to form the basis for future cooperation between the CDU and Greens in Germany. This suggests that the CDU will attempt to avoid snap elections for as long as possible and certainly until a new European Commission is in place.