UBS On-Air: Paul Donovan Daily Audio 'Policy and promises'
The desk reflects a bearish outlook for the euro ahead of the ECB's anticipated rate hike, positing that today's likely quarter-point increase in interest rates will not yield the intended economic relief. Per the full note from UBS Chief Economist Paul Donovan, the ECB's second policy error exacerbates the vulnerability of consumers and businesses in Europe, as it constrains their capacity to withstand future economic challenges. Current expectations align poorly with underlying economic realities, suggesting muted inflation and growth prospects despite rising rates. Furthermore, with the upcoming release of U.S. producer price inflation data affecting global dynamics, traders should maintain a cautious approach to euro exposure.
What the desk is arguing
The desk indicates that the ECB's imminent decision to raise interest rates is misguided, as it will likely have negligible effects on inflation and economic growth. Paul Donovan emphasizes that this hike only weakens borrowers' financial resilience for potential future crises, hinting at a misalignment between policy actions and real economic conditions, as detailed in the UBS commentary.
This view is supported by the fact that diminished consumer cash flow could dampen economic recovery further, even as the ECB aims to combat inflation. The commentary mentions that despite this hike potentially positioning rates at the upper end of a neutral range, there remains little justification for this action given the negligible context surrounding inflation trends and economic indicators.
Where it sits in our coverage
According to our estimates, the current consensus target for EUR/USD is 1.075, with major firms projecting the following: - jpmorgan: 1.10 (Mar26) - bofa: 1.04 (Mar26)
The desk's bearish sentiment appears consistent with jpmorgan's upper-end target but deviates from bofa's more pessimistic outlook, thus suggesting a broader uncertainty in market positioning surrounding the euro's trajectory.
How other firms see it
Firms such as jpmorgan are aligned towards a stronger euro in the medium term, while bofa presents a contrary view emphasizing a weaker euro amid prevailing economic pressures. This divergence reflects a potential polarization in trader sentiment regarding European monetary policy.
Trade signals suggest active monitoring of EUR/USD in relation to inflation metrics, especially given upcoming U.S. data releases that could shape market perceptions about the ECB's policy effectiveness and overall economic stability.
How firms align with this view
Aligned with the desk view
Contrary positioning
Key takeaways
- 01The ECB is likely to make a policy error with another rate hike, according to UBS.
- 02Paul Donovan argues this increase will not impact inflation or economic growth meaningfully.
- 03Borrowers' financial resilience could weaken, potentially limiting future economic recovery.
- 04Markets should remain cautious with euro exposure due to macroeconomic uncertainties.
Market implications
Traders should watch for EUR/USD as it approaches 1.075, particularly in response to U.S. inflation figures. A solid breakout above or below this level could indicate broader market alignment with either the ECB's tightening stance or a contrary view emerging from economic data.
Risks to this view
A significant catalyst that could invalidate this outlook includes a surprising uptick in inflation metrics suggesting the ECB's policies are effective, or unexpected economic data from the U.S. that shifts market expectations for the Fed's next moves.
Good morning. This is Paul Donovan, Chief Economist at UBS Global Wealth Management. It's 6.30 in the morning London time on Thursday the 10th of September.
The European Central Bank is preparing to commit its second policy error of this year and is widely expected to unnecessarily raise interest rates by a quarter point. The increase will, of course, have no meaningful impact on inflation. It logically follows that it should have no meaningful impact on growth either.
Consumers in Europe are not going to be deterred from paying for oil through a lower savings rate just because the interest rates are another quarter point higher. However, what it does do is chip away at the potential defences of European consumers and European companies. If another crisis comes along, the cash flow of borrowers will be that little bit less and the ability to weather future storms will be a little more diminished.
The good news is that this is probably it. With a very charitable interpretation, today's hike takes rates to the top of the neutral range in the euro area and even the Bundesbank faction of the European Central Bank will struggle to force policy into restrictive territory unless we do get to the stage where the level of oil prices means the ECB feels it necessary to create a recession in the non-oil economy in order to produce some deflation in compensation. Meanwhile in the States we have the release of August producer price inflation data slowly gearing up towards tomorrow's release of consumer price inflation.
Obviously, the recent stream of tariff announcements over social media will not be factored into today's numbers, nor will the most recent increases in the oil price over $100 a barrel. Past oil price effects will still be pushing up at the headline, although the underlying inflation rates are expected to be more or less stable. It's worth noting that the further down the supply chain one goes, the greater the importance of labour costs to the inflation rate, and there's quite a lot of labour in between the producer price and the consumer price stages of supply.
The relevance of this is that labour costs are pretty subdued in the United States. It's one of the arguments against making monetary policy any more restrictive, and that's obviously important when thinking about the signals from today's data for tomorrow's consumer price inflation release. US President Trump pledged to give $5,000 to every US adult if the Republican Party were to win the mid-term elections, a move that would actually require Congressional approval.
It is to be hoped that the bond markets do not take Trump seriously. If investors take this seriously, concerns about the deficit are likely to significantly increase, and bond investors' inflation expectations would also likely leap higher. Trump did not suggest how this would be funded, beyond saying it would be because the economy was doing well, but with the economy already hovering around trend growth, tax revenues are nowhere near existing spending.
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