Week Ahead & in Review: Waiting for the Government

Week in review: In Portugal, the President has reportedly given elected parties until Tuesday to reach a deal and form Government. The coalition PSD/CDP-PP won the general election but has less than half the seats required for an absolute majority. The expectation ahead of the election was that PS, the second party with most seats, would explicitly or implicitly allow the coalition to form Government, avoiding active opposition to the programme or the Budget. However, the leader of PS has started conversation with far-left parties Bloco de Esquerda (BE) and the Communist party (PCP) to attempt to form Government. It would require both of them to be able to form a left-wing Government. If PSD/CDS-PP and PS both fail to show that they can form a stable Government the President may need to call for new elections, which, given constitutional limitations, cannot take place before April 2016. Under such a scenario, Portugal would be under a caretaker Government and would apply the 2015 Budget until the new election (with the exception of measures that were designed for 2015 only, such as  civil servant wage cuts and special taxes on pensions). The Conselho das Finanças Públicas, a public but independent institution that monitors public finances, has published a report which states that in that case, in absence of further measures, the deficit would be above 3% in 2016 and would decline only very slowly to 2.4% in 2019. This would mean that structural deficit would actually rise from next year onward, taking Portugal further away from the Medium Term Objective of a structural deficit of 0.5% of GDP.

In the Euro Area, inflation fell to -0.1%yoy in September, down from 0.1% in August. Core inflation (excluding energy and unprocessed food prices) fell 0.1 pp to 0.8%yoy. Though there are no risks of deflation, inflation remains very subdued despite the weakness of the euro, which suggests that the ECB policy is affecting the real economy only very slowly. This may mean that the ECB will effectively need to pursue its bond purchasing programme beyond September 2016.

In the US, two Federal Reserve board members explicitly excluded approving a rate hike in the near term. The split at the top of the Fed suggests that the first rate hike may be pushed beyond the end of the year, scenario that was being priced in as most likely by the markets until now.

Week ahead: Confidence indicators (EU Commission consumer confidence on Thursday and PMIs on Friday) should continue to show a very gradual improvement, consistent with moderate growth. The ECB meets on Thursday, no change expected. The Portuguese President will name the next PM probably by the middle of next week but the real test will come when the Parliament meets to discuss the Programme. Parliament is expected to convene on the 22nd (may be later due to a dispute over results in Macao).