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PATRIS Fixed Income Weekly - 14 September 2018

14 Sep 2018

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WEEKLY COMMENTARY

 1.The September ECB meeting brought little new information, as broadly expected. The main highlights of yesterday's policy meeting were the positive assessment of growth (in spite of the slowdown in GDP growth from a 2.7% q/q saar pace recorded last year to 1.6%q/q saar in 1H18) and the higher confidence on inflation. Euro area real GDP growth was revised marginally lower, from 2.1% to 2.0% in 2018 (vs. 2.4% in March 2018) and from 1.9% to 1.8% in 2019, reflecting external developments. Risks to economic growth were still viewed as broadly balanced. Mario Draghi stressed the uncertainties related to emerging markets, protectionism and financial market volatility, but also highlighted some upside risks, including fiscal policies in the US and in some euro area members. On inflation, median staff projections were unchanged at 1.7% over the 2018-2020 forecast horizon, although core HICP inflation was revised lower by 0.1pp to 1.5% in 2019 and 1.8% in 2020 (the same projections were seen in December 2017). The introductory statement noted that uncertainty around the inflation outlook was receding, and that underlying inflation is expected to pick up towards the end of the year. The ECB recognises that domestic cost pressures are strengthening and broadening, reflecting high capacity utilization and a tighter labour market. Mario Draghi said that the Governing Council has yet to discuss the reinvestment policy and stressed that the capital key will remain a guiding principle. Markets continue to see the ECB satisfied with the current dovish pricing for interest rate hikes in 2019.

 2.In the US, the August CPI data showed once again that the US economy is still creating little inflationary pressure. Core CPI posted a weaker-than-expected 0.08%m/m increase in August, with the annual rate of change slowing to 2.2%y/y from 2.4%y/y in July. Excluding shelter, core inflation stood at 1.3%y/y. While wages have been on an uptrend, price pressures remain moderate, while expectations for future inflation remain well anchored. Yesterday's data do not change the view of a 25bps rate hike at the 25/26 September FOMC meeting. Focus should remain on the updated SEP and "dot plot". Many Fed officials continue to stress that the link between wages and inflation is tenuous. However, in the end, inflation is a highly lagging indicator, which means that the debate around inflation is likely to go on over the coming months...

 3.In Italy, BTPs have stabilised after a strong rally since the beginning of the month. The spread between 10-year BTPs and bunds narrowed to about 250bps, from 291bps at the end of August, reflecting the market perception of a lower fiscal risk. The release of the draft budget later this month or in early October could now be decisive to potentially support an even lower spread. A more favourable economic backdrop would also probably give some help. On a more negative note, press reports suggest that government plans to lower the retirement age with the 2019 budget law. This could reverse most of the benefits of the 2011 pension reform, with negative effects on the labour force participation rate, which could weigh on rating agencies' future decisions on Italy's sovereign credit rating.

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