Macro update - November

ECB opts for ‘lower-for-longer’ QE extension

In line with our expectation, during the October meeting of its Governing Council the ECB announced an extension of its QE programme until September 2018 but scaled down the asset purchases to EUR30bn from January 2018 onwards. The ECB retained the possibility to extend the QE programme in size and/or duration, leaving it open-ended. The ECB reiterated that policy rates will remain at their current levels for an extended period of time and well past the horizon of asset purchases.

The ECB’s QE scale-down decision reflected growing confidence by the Governing Council that inflation will eventually converge to target based on an increasingly robust and broad-based economic expansion in the Eurozone. Nevertheless, so far inflation pressures remain muted and hence the ECB stressed the continued need for monetary support through the QE purchases.

The drop in EUR/USD on the initial policy statement clearly suggests that some expectations in the FX markets had been building ahead of the meeting that the ECB could go with a more hawkish taper. In our view, the continued commitment to stay accommodative suggests a firm move in EUR/USD above 1.20 is not on the cards until 2018, as the ECB seems very wary of taking exit talk too far at the current stage. Obviously, a big concern for the ECB for most part of 2017 was strengthening euro, which further pushes inflation down. We expect EUR/USD to stay below 1.20 for the rest of 2017 but move towards 1.22 and 1.25 in the 6M and 12M horizon respectively.

ECB confident about rising inflation going forward

Source: ECB, Macrobond, Danske Bank 

Oil price on the rise

The oil price has been on a rally since the lowest point reached in June, the price of Brent crude having climbed from USD45 to USD64 per barrel at the beginning of November. The move in EUR terms was from EUR40 to EUR55 per barrel.

The oil market has been affected by a series of extraordinary events over the past couple of months. They include Storm Harvey and Hurricane Irma disrupting crude and refinery production in Texas and giving rise to temporary precautionary buying, rising geopolitical tensions between the US and Iran threatening the 2015 nuclear deal in addition to ramblings around Turkish-Kurdish oil trade over the Turkey-Iraq border. While the market has also been flooded with comments from OPEC members and Russia regarding the outlook for an extension of oil production cuts towards end-2018, production in Libya has dropped back but is now looking to recover.

Overall, we look for world oil production to continue to grow on the trend from the past decade. The recent decline in the US oil rig count suggests that higher output from, e.g. Libya and Nigeria is crowding out further increases in US output. For now, it looks more probable than not that OPEC and Russia will eventually announce an extension of output cuts beyond March next year. On the demand side, we expect economic growth to stay strong for the rest of this year, while the outlook for next year looks a bit more uncertain.
We maintain our forecast that the average oil price in 2017 will constitute USD53 per barrel, while the price in 2018 should be USD58 per barrel. Given that we project a stronger EUR/USD in 2018, this should mitigate the effect of more expensive crude in EUR terms. As a result, the price of standard gasoline in Latvia next year should remain within the EUR1.10-1.20 range.

Oil and gasoline price in Latvia

Source: Macrobond, Danske Bank

Latvian GDP shoots up

Latvian GDP growth in Q3 17 was 5.8% y/y, the fastest since early 2012. Although we expect economic growth to moderate in Q4 and into 2018, average GDP growth in 2017 will stand at 4.4% and 3.4% in 2018.

Latvia is enjoying a period of balanced growth this year, as all key GDP components are expanding at a healthy rate. Retail trade, a proxy for consumption, grew by 4.7% in Q3 17 y/y. Consumption is being driven by rapidly expanding wages, which are growing by around 8% this year.

Another factor is investment, which is expanding due to higher disbursement of EU funds, elevated capacity utilisation rates and recovering business confidence. In the first half of 2017 investment activity grew by 17.5% y/y. The trend is likely to have continued in Q3 17 as well.

Finally, an important contributor to growth this year is exports. As preliminary data shows, real exports of goods in Q3 17 expanded by 3% y/y. This year exports are expanding in all key markets. The single country that added most to exports in January-August was Russia, to which exports grew by 39% y/y. In terms of regions, exports expanded most to Nordic markets and other EU countries. The key categories to have grown overall were iron and steel products, beverages and electrical equipment.

Quarterly GDP growth, Latvia (y/y)

Source: Statistics Latvia, Macrobond, Danske Bank