ECB: no urgency to remove monetary stimulus……..
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Intesa Sanpaolo – Research Department For professional investors and advisers only
As Trump heads to complete his first 100 days in office, the administration has frantically stepped up the pace of its activity, on three fronts: taxes, healthcare, and NAFTA.
1) Taxes. The backbone of a tax reform (or, rather, of a mega-cut) is a massive reduction in tax rates. For businesses, from 35% to 15% for corporations, from 39.6% to 15% for pass-through companies. As regards households, both the number of rates (from 7 to 3) and the level of the top rate (from 39.6% to 35%) would be reduced; deductions for low income households would increase, and the 3.8% additional tax on investment income, introduced with Obamacare, would be abolished, as also the Alternative Minimum Tax, the estate tax, and the deduction of state and local taxes. The information available so far, lacking all the relevant details to assess the impact of the measures, imply that i) it will take time and long negotiating to craft a workable plan acceptable for the various factions of the Republican party, to the detriment of a simplification of the tax system; ii) in all likeliness, the deficit will increase along the whole forecastable horizon, also beyond 10 years; iii) the plan will expire after 10 years and will not be permanent.
2) Healthcare. The administration has revamped the healthcare reform, removing some components opposed by the conservative Republicans, which could now garner approval by the House of Representatives (although the vote of the moderate Republicans in the Senate would be highly uncertain).
3) NAFTA. After press reports indicating the likelihood of a unilateral recess of the US from the Treaty (in the President’s powers, with a notice of 180 days), and following the heightening of trade tensions with Canada on several fronts, Trump stated that he does not intend to pull out of NAFTA for now. If future negotiations don’t provide a deal “fair for all”, then the treaty will be terminated. The pillars of the Trump manifesto have reappeared in force in this final rush: tax cuts (and larger deficits), healthcare, and protectionism. One main factor is unchanged: the timeline for the tax reform remains lengthy and uncertain.
The ECB is in no rush to review its inflation bias. Draghi seems to have succeeded in reining in the Council on cautious positions, probably aided by the recent exchange rate and interest rate movements. The ECB President reasserted that discussing an exit from non-conventional measures is still premature, and that in any case the sequence laid out in the guidance on rates stays in place.
The ECB has maintained the inflation bias implied by reference to rates at their present levels, or lower, until after termination of the APP. Despite stronger than expected recent data, the Council, after a long debate, has only marginally altered its assessment of risks to growth, that are now defined as being more balanced but still “tilted to the downside”, mostly due to external factors. At the same time, the Council has opted to ignore inflation volatility and remains focused on core inflation,agreeing on the fact that no convincing signals of an increase in domestic prices have emerged. Downside bias, Draghi explained, is tied to the assessment of risks to the inflation trend. Reduced risks to growth, and to the trend of domestic demand, have attenuated risks to core inflation, but not to the point of removing the bias. We believe that in June the ECB will review its assessment of risks to growth to “balanced”, indicating that risks to core inflation have further decreased. However, a change in the ECB’s guidance, with a removal of reference to the possibility of lower rates than at present, should not be taken for granted. Much will depend on the trend of domestic prices.
Core inflation has risen back in April to 1.0%, but the ECB will have to verify that the trend is confirmed. The underlying trend of prices should stabilise until the end of the summer at around 1.0% or just above, and subsequently backtrack to 0.9% at the end of the year, depressed by an unfavourable base effect. In any case, positive news on the cycle support our view that the ECB will begin the process of gradually normalising monetary policy starting in early 2018. For details on the technicalities, we will probably have to wait until after the German elections.
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