ECB: Many participants may be disappointed on July 21 - BBH

Research Team at BBH, suggests that on July 19, the ECB's lending survey will be reported and it will likely acknowledge that a tightening of lending conditions took place in Q2. 

Key Quotes 

“Two days later, the ECB meets.  The post-Brexit decline in yields exacerbates the shortage of German bunds that qualify for the ECB's purchase program.  This has increased speculation that the ECB will abandon the capital key (determined by the GDP and population) which favors the large countries, and especially Germany.  The alternative that has captured many imaginations is a debt market key, which would favor the large debtors, especially Italy. 

We suspect the market is getting ahead of itself.  First, the capital key is a very important principle that the ECB will be reluctant to abandon without exhausting milder measures.  Second, less aggressive measures do exist, such as removing self-imposed limitations like the deposit floor on purchases or the country cap.  Third, some investors and commentators may have a greater sense of urgency than officials.  After the initial drop in response to the Brexit decision, yields have backed up in recent days. 

If we are correct in our assessment, many participants may be disappointed with the ECB on July 21.  The economy and prices are evolving pretty much as the ECB expected.  The flash PMI for July is released the day after the ECB meeting, and the composite is anticipated to slip lower but should still be consistent with around 0.4% Q2 GDP growth.  The capital markets have stabilized and by many metrics, not far from where they were on the eve of the referendum.”