When it comes to monetary policy, the Global Financial Crisis and Great Recession continue to cast a long shadow.
Optimistic supporters of globalization hope that 2017 might be seen as turning the tide against nationalist political movements, after France and the Netherlands avoided populist victories in the first half of the year. As investors, we are not so hopeful and believe policy uncertainty will remain elevated due to political shifts across the globe.
Housing market activity is set to expand in all major European markets this year, fueled by historically low lending rates and gradually accelerating economic growth. We expect housing prices will continue to rise through 2018 because we believe the European Central Bank will maintain ultra-low rates, with no hike before 2019
Monetary Policy Outlook
Since 2008 all the major central banks in Europe have followed very accommodative policies to various degrees, essentially comprising interest rate cuts to historically low levels and asset purchase programs on financial markets (quantitative easing; QE). Those policies have undoubtedly contributed to the economic recovery in the region after the great financial crisis. They also facilitated a gradual upturn in residential real estate markets after the initial and often sharp correction in prices. The combination of very low borrowing rates and lower prices has boosted the purchasing power of European potential buyers, but to various degrees across the region.
As economic growth accelerates (except in the U.K.) the timing of the policy normalization by the central banks (through rising rates and tapering off of QE) has become a critical issue. Our view is that the central banks will exercise extreme caution in this process.
European Central Bank: No hike before 2019
Despite the strong acceleration in GDP growth, to about 2% this year, the lack of pickup in headline inflation across the monetary union appears to justify the central bank's continued accommodative stance. The ECB's balance sheet is still expanding as fast as in early 2015, although economic conditions have improved since then. The challenge for the ECB will be to avoid confusing markets in its forward guidance by leading them to anticipate too quick a "tapering-off "of its QE program, causing yields to spike prematurely. Our view is that the ECB's normalization sequence will extend through 2019 as wage growth and inflation prospects improve only very slowly given the amount of slack that remains in labor markets. The ECB's QE scaling down could be announced at the next September meeting and implemented from January of next year, with its monthly pace initially cut to €40 billion and then to €20 billion in the second half of 2018. Once its QE program reaches an end in early 2019, the bank is likely to start slowly raising its policy rate with one hike that year and two hikes in 2020, and eliminate its negative deposit rate. As a result, our forecast is for a very slow increase in long-term rates in the European Economic and Monetary Union (EMU) in the coming three years.
The Bank of England between a rock and a hard place
The Bank of England (BoE) faces a different dilemma. After the Brexit referendum fears of a marked slowdown in growth led it to resume a very accommodative policy with a rate cut and a temporary QE program (now over). But the weaker pound exchange rate has fueled a pickup in the inflation rate. At this point, the bank's monetary policy committee seems divided between hawks in favor of a rate hike and doves arguing for continued support to the economy. The U.K. economy faces idiosyncratic risks, in our view, with a minority government since the parliamentary elections last June and increasing signs that the Brexit negotiations with the EU will be long and hard. In the near term, it's unlikely that investment and net trade will fill the growth gap that slowing consumption creates, or that pay growth will accelerate substantially so that conditions for a hike would be met. We expect the current ultra-accommodative stance to continue over the medium term, and predict a first rate hike to occur only in mid-2019.
The Swiss National Bank: Waiting for the ECB
At its June meeting, the Swiss National Bank (SNB) left its deposit at a record low of -0.75% and reiterated its willingness to intervene in foreign exchange markets if needed to prevent an unwarranted appreciation of the Swiss franc. Economic growth is decent at about 1.5% this year and next, and inflation has finally returned to positive territory to average 0.3% in our forecast (-0.4% last year). We believe the SNB won't pre-empt the ECB in normalizing its monetary policy, and will retain interventions in the foreign exchange markets as its main policy tool. Given our views on the ECB's rate outlook, we do not anticipate any move by the SNB on its policy rate before 2019.
We expect Ireland's housing market to experience the strongest year-on-year nominal house prices rises of 8.5% this year and 7% in 2018, underpinned by supply shortages and continuing economic recovery. The Brexit-related relocation to Ireland of some of London's financial sector workers should also support the market. Conversely, we expect price rises to slow in the U.K. to 2.5% overall this year, and to decline by 1% in 2018 on Brexit uncertainties, although still supported by pent-up demand and favorable financing conditions.
The German residential property market continues to boom on tight supply and a strong economy, but our forecast of a 7% year-on-year gain this year is slower than in 2016 as more new construction eases the pressure. The Netherlands' strong housing recovery should also continue this year, gaining 7%, on rising income, supply shortage, and sustained low interest rates.
House price inflation in Portugal and Spain, of 6% and 4%, respectively, are both being aided by foreign buyers.
We expect Belgian house-price growth will be dynamic at 4% this year and 3.5% in 2018 on the back of solid economic performance. But, further ahead, the prospect of gradually rising borrowing rates and a less favorable mortgage tax regime should soften house price rises. In France, rising consumer confidence could lift prices by 2% this year, but they could flatten next year on the back of forthcoming fiscal measures. In Switzerland, high prices and regulatory measures are likely to keep a lid on house price rises (1.3% in 2017 and 1.5% in 2018). Italy is experiencing the slowest price rise among major European markets, at a forecast 0.5% this year, after a prolonged period of decline, due to weak economic recovery.
Sophie Tahiri - Economist - Standard & Poor’s
In reaction to the Bank of England (BoE) Monetary Policy Committee (MPC) meeting, Tim Graf, head of macro strategy for EMEA at State Street Global Markets, and Alan Wilson, senior investment manager of active fixed income at State Street Global Advisors, offer their views.