Question of the week: Is the services-lockdown hit to Q4 GDP growth in the EZ priced in?
A: It seems like a lifetime ago that the ECB sounded a confident tone on the EZ economy and inflation, predicting that the economy would expand by a punchy 3.1% quarter-on-quarter in Q4. Yet, this is what the central bank said in September. We shouldn’t hold the ECB to this call, even if it remains the official forecast before the numbers are updated in December. Ms. Lagarde said so explicitly in the October press conference, when she noted that the central bank’s Q4 number would have to come down significantly in the new staff projections. The question for investors is whether the shift in the outlook is priced-in. We suspect it is.
A survey by the Financial Times at the start of November indicate that economists now expect the EZ economy to contract by 2-to-3% quarter-on-quarter in Q4, which seems reasonable to us. In other words, the true consensus has already factored-in that the EZ economy will take a hit in the fourth quarter, even if actual reported forecasts still need to be adjusted lower in many cases. In markets, EZ equities initially fell about 10% in the latter part of October, but have since rebounded sharply, driven by the global rally in risk in the wake of the likelihood of a Biden win in the U.S. presidential elections. In short, EZ equities will be driven by the twists and turns in U.S. politics just as much as domestic economics over the next few weeks. More generally, the renewed downside risk comes with the clear promise of further monetary stimulus. The ECB promised as much in its October meeting, and expect a boost to QE in December. Should the economy weaken beyond what the consensus currently expects, for example if lockdowns in services are extended through December, we have no doubt that the ECB would respond with a bigger lift to QE.
The chart shows the difference between our forecasts and the ECB’s September baseline. The key point is that the central bank’s forecasts will look a bit more like ours when the new staff projections are released in Q4, paving the way for new stimulus.
Chief Eurozone Economist