While we previewed yesterday why Wall Street consensus expects Draghi's statement in a few minutes to be "dull", with the ECB expected not to make any material chances to policy so soon after its dramatic December meeting in which it laid out a series of revisions to its monetary policy, there is still scope for surprise, especially as a result of the recent jump in inflation metrics across Europe and especially Germany.
As the WSJ recalls, in Germany, Europe’s biggest economy, objections to the ECB’s easy-money policies are mounting once again, triggered this time by a jump in inflation to 1.7% last month. German politicians and economists want to know when the ECB will start winding down its controversial bond-purchase program, known as quantitative easing. So, too, do investors: As such, any announcement of “tapering” over and above what was announced in December, would spark financial-market volatility and a selloff in rates, as investors reprice financial assets.
Meanwhile, political uncertainty looms large over the 19-nation currency union. A series of major elections are scheduled this year; Britain’s negotiations to leave the European Union will start in earnest; and across the Atlantic, U.S. economic policy looks set for a radical shift.
So what to expect?
As a reminder, at last month's meeting the ECB kept all rates on hold as expected (Main Refinancing Rate: 0.00%, Marginal Lending Facility: 0.25% and Deposit Facility Rate: -0.40%). However, crucially the central bank extended their QE program by 9 months, but reduced monthly purchases by €20BN (from €80BN to €60BN) as of March. Despite the cut in monthly purchases, Draghi refuted claims of tapering, suggesting that tapering is setting a plan in place to eventually move purchases to zero and although they have been reduced, complete removal is not on the table.
Since the last meeting the ECB have been able to digest encouraging inflation figures for the Eurozone in which the headline figure rose to its highest level since late 2013 at 1.1%. As such, this could potentially support the thinking of the more hawkish members who suggest the ECB would need to wind down asset purchases sooner rather than later. However, core inflation remains subdued and still some way off the central banks 2% target.
Subsequently, this has sparked a dispersion of opinions amongst the council highlighted in the latest minutes release stating that a few saw the need to extend QE by 6-9 months at EUR 60b1n/80bln, while some a few saw no need to extend QE. As such, it is likely that the ECB will keep a more cautious view on inflation. Elsewhere, activity data within the Eurozone has surprised to the upside with the latest Eurozone economic confidence figure reaching its highest level in 5 years, while industrial production data has also come in stronger. Consequently, indicating that Q416 and Q117 are on track to print strong growth in GDP. In turn, this could potentially lead to a more upbeat tone from the ECB with the possible removal of "downside risks" in its statement which may be perceived as hawkish. Additionally, with the central bank now beginning to make purchases below the depo rate, it is possible that the ECB may be questioned as to its effectiveness regarding bond scarcity.
With that said, here is a five step prime of what to watch for in today's ECB annoncement, courtesy of the WSJ:
- What Is the ECB Expected to Do This Week?
Play it safe. No policy changes are expected so soon after the ECB’s decision to extend QE in December. Mr. Draghi will aim to be dull, economists say, citing the need for more than a month’s worth of data. He’s expected to repeat his message that the economy is improving but still needs support, and that the current dose of stimulus could be augmented if the outlook worsens.
- Has the Eurozone Economy Recovered?
It’s getting there. Economic activity surged to a five-year high in December, according to a closely watched business survey, and unemployment is at a seven-year low. Credit markets remain strong, and the euro has fallen toward parity with the dollar, a boon for the region’s exporters. That robust performance appears to vindicate the ECB’s decision in December to scale back its bond purchases from April, to €60 billion a month from €80 billion.
- So When Can QE Be Wound Down?
That is the key question that Mr. Draghi faces this year. For now, inflation is some way below the ECB’s target of just under 2%. Core inflation, excluding volatile energy and food prices, is stuck below 1%. But if the economy strengthens further and inflation continues to rise, the ECB will come under pressure to signal a possible exit from QE. Mr. Draghi has so far carefully sidestepped the debate, claiming the topic hasn’t even been discussed at policy meetings. On Thursday, he may try to fend off premature calls for tapering and reiterate the ECB’s independence in the face of German political pressure.
- What Else Could the ECB Do?
Economists don’t expect any signal on tapering before the summer. But there are some intermediate steps the ECB could take. Mr. Draghi could signal, for instance, that the ECB won’t cut interest rates again, an option he has carefully left open. Or he could indicate that the pace of QE could be slowed again, as it was in December.
- What about Donald Trump?
Mr. Draghi has refused to be drawn on the ramifications of economic policy changes in the U.S. Besides signaling a large fiscal stimulus and possible trade barriers, Mr. Trump this week surprised investors by saying that the dollar is too strong. The U.S. currency duly slumped, though it has since recovered. Mr. Draghi may speak out about the risks of currency wars, or a resurgence of economic protectionism.
Finally, how will the emarket react?
Given the alteration to the central banks monetary policy last month, it is likely that ECB will take a wait and see approach. Although, the general tone of Draghi's press conference, as always, has the significant risk of guiding market reaction with a less dovish rhetoric from Draghi and Co. in response to the upbeat data in the Eurozone could be supportive for EUR, weigh on equities and result in a flatter curve.
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Althought ECB President Mario Draghi may sound slightly hawkish at Thursday’s press conference after an unexpectedly strong acceleration in CPI in December and European economic growth modestly picking up, the ECB is set to argue on Thursday that its extra-easy policy stance is still needed to keep the recovery on course. As a result, it is all but certain to leave current monetary policy in place and maintain a promise for lengthy stimulus, having extended its bond-buying program just last month coupled with the tapering (just don't call it a taper) of its bond purchases this year.
ECB President Mario Draghi can argue the bank has done its part to mend growth, but he will also note the recovery is not self-sustaining, underlying inflation is weak and political risk from key elections weighs on the outlook. So turning down the ECB taps now is inappropriate, he is expected to say.
According to Reuters, on the face of it, Draghi should be relaxed. Inflation hit a three year high of 1.1% last month (the ECB expects it to hit 1.7% in 2019), manufacturing activity is accelerating and confidence indicators are firming, all pointing to solid growth at the end of last year. Additionally, euro zone business growth was the fastest in more than five years in December, order books are surging on export demand, and consumption is holding up, despite rising energy costs, all pointing to the sort of resilience not seen since before the bloc's debt crisis. Of course, it could all be transitory as the "Trump" effect shifts to Europe, but the answr won't be known for a few more months.
So what does Wall Street expect? According to a Bloomberg survey, the ECB will wait until at least its meeting on Sept. 7 to announce any new policy measures As a result, Bofa strategists expect Draghi to sound “as dull as possible” to keep the message sent at the previous meeting intact. Confirming this, ECB’s Yves Mersch said on Jan. 6 that improving euro-area economic numbers and a faster-than-forecast inflation pickup aren’t enough to warrant an immediate shift in the policy.
Here is a summary breakdown of select outlooks:
BofAML (Athanasios Vamvakidis, Gilles Moec)
- Draghi will endeavor to be as dull as possible, so as not to generate too many expectations on any further change in stance any time soon
- Any deviation from the December message on the inflation outlook and/or further delay in the implementation of the new QE parameters would create scope for bonds to underperform current forwards
- Risk for euro small and balanced; any hawkish statements that strengthen the euro during the Q&A could be an opportunity to sell EUR/USD again
JPMorgan (strategists including Fabio Bassi)
- Don’t expect the ECB meeting to break much new ground; ECB will likely express satisfaction at the improvements in the growth and inflation outlook, at the same time stressing that there is no reason to think about tapering more quickly than the Dec. announcement
NatWest Markets (Anna Tokar, Giles Gale)
- Unlikely to give significant new clues to the ECB’s reaction function
- Since the Dec. meeting, data has been solid; expect the Council’s economic assessment may be slightly more optimistic, in line with the assessment of the Eurozone growth outlook
- However, policy debate should be unchanged and simply reference the decisions taken in Dec
Citi (strategists including Harvinder Sian)
- Meeting is too close to the policy moves enacted last month to warrant a material shift in ECB tone, even if data has been more buoyant than expected
- Any change to the reference of growth risks being to the downside will have to await more data and perhaps even clarity on the new U.S. administration’s policies
- Think that any further tapering risk starts from June meetings onwards, but the rise in oil prices and a drop in euro could see markets re-price from the March staff forecasts
- Expect some focus on the 33% issue limit, with Draghi likely to repeat that there are legal issues in up- sizing the issuer limit on legal grounds; many investors don’t believe the limit is a hard line in the sand –- despite the fact Portuguese and Irish bond valuations already reflect a less supportive ECB backdrop
UniCredit (economist Marco Valli)
- ECB President Draghi will sound constructive, but dovish
- He will probably acknowledge that risks in the short term are moving toward faster-than-expected headline inflation and more balanced growth assessment
- Also expects Draghi to emphasize that uncertainty remains elevated and the medium-term outlook hasn’t changed much from last month
- ECB still wants financial conditions to remain very loose
Deutsche Bank (strategists including Francis Yared)
- Next step for the ECB should be to shift to a neutral stance by removing reference that rates may go lower in the introductory statement; may be too early to do so in Jan. meeting, but the overall tone of the press conference should suggest that the policy stance is evolving in that direction
ING (Carsten Brzeski)
- The December decision has put the ECB on autopilot at least until the summer and until after the Dutch and French elections. This autopilot should also immunize the ECB against short-term volatility in macro data.
- The lending channel is no longer clogged up, but it is not completely free either and progress has only been possible thanks to massive measures by the ECB. If monetary policy were to be tightened again, and the burdens from existing loans were to increase once more, the lending channel would close and the economic picture would worsen considerably again.