Waiting for Godot – Waiting for depo

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• The euro area economy has slowed significantly over the past year, from 2.5% to 1% annualised. Core inflation has been stuck around 1% since 2016. This unfavourable momentum may prevent any monetary policy normalisation, raising the probability of our risk scenario “European Central Bank (ECB) stalemate” to 40%.
• In this scenario, the ECB does not hike rates until the next cyclical upswing, so key interest rates remain at their current level (-0.4% for the deposit rate) until 2022, beyond current market pricing.
• This would see lower for longer euro long-term yields, typically with Bund still at 0.1% by end-2020, with a risk that collateral scarcity could pull yields even lower into negative territory.
• Another three years of negative interest rates weighing on banks’ profitability could reduce their lending appetite. Mindful of this risk, the ECB might introduce a tiering system, but we believe it would only be a partial solution