UBS: Eurozone - strong data to embolden the hawks

Expecting stronger Eurozone growth in 2017, remaining cautious on 2018

Eurozone GDP grew by a strong 0.5% q/q in Q4 2016, while Q3 growth was revised upwards by 0.1pp to 0.4% q/q, thus rendering a 2016 growth rate of 1.7%. Strong growth in late 2016, but also indications of a good start to 2017, prompt us to raise our 2017 Eurozone GDP forecast to 1.5% from 1.3% (consensus 1.4%). However, we maintain our conservative 2018 growth projection of 1.2% (consensus 1.5%) as we expect higher inflation and commodity prices, as well as some tightening in financial conditions, to lead to a deceleration in domestic demand later in 2017 and 2018.

Big jump in inflation in January, further rise to 2% expected by April

Driven mainly by energy pieces, Eurozone inflation (HICP) jumped up very significantly in January, to 1.8% y/y from 1.1% in December; core inflation stayed unchanged at 0.9% y/y. Given energy-related base effects, we project HICP to rise further to 2% by April, before easing somewhat. We now expect annual average inflation to pick up from 0.2% in 2016 to 1.8% in 2017 (prev. 1.4%) and 1.7% in 2018 (prev. 1.8%). We would highlight that our updated inflation forecast is now well above the ECB staff macro projection published in December, which had HICP at just 1.3% in 2017 and 1.5% in 2018. We firmly believe that the ECB will have to revise its projection markedly upwards when it releases new forecasts on 9 March.

Monetary policy debate to turn more hawkish, but our ECB call is unchanged

The sharp rise in inflation implies, in our view, that the monetary policy hawks will feel emboldened and demand more vocally a timely ECB move towards policy normalisation. Proponents of ongoing accommodation, however, will push back by questioning whether the rise in inflation is sufficiently durable, self-sustained, and broad-based. Overall, our ECB call remains unchanged: We expect the ECB to conduct monthly asset purchases of €60bn from April to December 2017, in line with its decision from 8 December. As of January 2018, however, we expect the ECB to start tapering and wind down its asset purchases over 12 months, i.e. until December 2018, with a decision due possibly as early as 7 September, or 14 December 2017 at the latest.

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