ECB Preview: Taper On Autopilot As Growth Is Downgraded

Unanimous expectations for tomorrow's ECB policy decision - due at 7:45AM ET with a press conference at 8:30AM ET - is for the central bank to leave its three key rates and tapering schedule unchanged, while macroeconomic projections are set to see a minor downgrade to growth forecasts. During the presser, Draghi is set to be grilled on trade protectionism, concerns surrounding Italy and the Bank’s reinvestment policy.

Below is a full preview of what to expect tomorrow, courtesy of RanSquawk.

BACKGROUND

PREVIOUS MEETING: The July meeting saw little in the way of fireworks after the Bank reiterated their view that they expect key rates to remain at present levels at least through the Summer of 2019, and as long as necessary to ensure the continued sustained convergence of inflation. During the accompanying press conference, Draghi gave little away and pushed back on questions trying to get him to pin down an exact timeframe for the next rate move by the ECB. Furthermore, Draghi stated that uncertainties relating to the trade environment remain prominent, but the Euro area economy is solid and broad-based.

ECB MINUTES: The minutes from the meeting were equally uninspiring and provided the market with little in the way of traction with the account highlighting that the threat of protectionism and prominent trade tensions could weigh on confidence. Furthermore, policymakers were unanimous in maintaining the policy stance and were satisfied that the June decisions are well understood.

SOURCE REPORTS: The only noteworthy sources since the previous meeting came this week with people familiar with the matter suggesting that the ECB will marginally downgrade growth forecasts and see downside risks to growth due to weaker external demand; inflation outlook set to be unchanged.

ECB RHETORIC: Commentary from the Bank has also been quiet over the summer period with little in the way of market moving rhetoric. Some have placed focus on the recent comms from ECB’s Rehn who some view as a potential successor to Draghi next year, with the central banker recently suggesting that markets are correctly interpreting the ECB’s rate guidance. Elsewhere, the new(ish) VP at the Bank, de Guindos, stated that economic growth in the Euro area remains solid and broad-based whilst noting that risks surrounding the growth outlook are balanced, but uncertainties remain; something which appears to be in-fitting with the central narrative on the governing council. Finally, Nowotny has continued to stick to his hawkish stance by recommending that the ECB should focus on getting the deposit rate out of negative territory and is in favour of a faster pace of policy normalisation.

DATA: In terms of developments since the previous meeting, Q2 Q/Q GDP printed at 0.4% (ECB Exp. 0.5%) with Y/Y growth slowing to 2.2% vs. 2.5% seen in Q1. On the inflation front, July headline Y/Y CPI rose to 2.1% (highest since Dec 2012) from the 2.0% seen in June, whilst core CPI rose to 1.1% in July (highest since Sep 2017) but remains subdued overall, according to GS. Elsewhere, for soft data, UBS highlights that “the July and August PMIs indicate an unchanged pace of growth, at 0.4% Q/Q; this would imply a Y/Y rate of 1.8%. In terms of the FX rate, GS states that the EUR has risen around 1% on a TWI-basis. Finally, encouraging signs have been seen on the wage front with Q2 wage growth picking up by 2.2%.

CURRENT ECB FORWARD GUIDANCE (INTRODUCTORY STATEMENT)

RATES: We continue to expect them to remain at their present levels at least through the summer of 2019, and in any case for as long as necessary to ensure the continued sustained convergence of inflation to levels that are below, but close to, 2% over the medium term. (Jul 26th)

ASSET PURCHASES: We anticipate that, after September 2018, subject to incoming data confirming our medium-term inflation outlook, we will reduce the monthly pace of the net asset purchases to €15 billion until the end of December 2018 and then end net purchases. We intend to reinvest the principal payments from maturing securities purchased under the APP for an extended period of time after the end of our net asset purchases, and in any case for as long as necessary to maintain favourable liquidity conditions and an ample degree of monetary accommodation. (Jul 26th)

GROWTH/TRADE: The risks surrounding the euro area growth outlook can still be assessed as broadly balanced. Uncertainties related to global factors, notably the threat of protectionism, remain prominent. Moreover, the risk of persistent heightened financial market volatility continues to warrant monitoring. (Jul 26th)

INFLATION: The underlying strength of the economy confirms our confidence that the sustained convergence of inflation to our aim will continue in the period ahead and will be maintained even after a gradual winding-down of our net asset purchases. Nevertheless, significant monetary policy stimulus is still needed to support the further build-up of domestic price pressures and headline inflation developments over the medium term. (Jul 26th)

POTENTIAL ADJUSTMENTS TO ECB FORWARD GUIDANCE (INTRODUCTORY STATEMENT)

RATES: No changes expected given that the guidance was altered at the June meeting and there has been little in the way to alter their expectations for rate lift-off, particularly given that the forecast is towards the back-end of next year. Changes on this front are not expected until nearer the time of the first rate hike. Interestingly, SocGen have floated the idea of a potential Fed-style dot-plot but there has been little sign thus far of such a policy being implemented.

ASSET PURCHASES: Similar to rate guidance, given that changes were made on this front at the June meeting and there has been little reason for the ECB to make adjustments on curtailing bond purchases, this part of the statement is expected to remain the same. At this stage, only a major imminent economic crisis could deter the ECB from carrying on with their planned unwind.

GROWTH/TRADE: As stated above, this week’s ECB source reports suggested the Bank sees downside risks to growth due to weaker external demand. That said, a complete overhaul of communication is seen as unlikely as policymakers attempt to navigate their way out of their PSPP without incident. On the trade front, SocGen suggests that “the Governing Council is not expected to have a better picture of the risk of a trade war with the US,” whilst Morgan Stanley expect the issue of trade protectionism to be continued to be described as a ‘prominent risk’.

INFLATION: RBC “don’t expect Draghi’s central message on inflation to change much from the last meeting” with the ECB President due to downplay the importance of the recent performance for headline CPI given the struggles the Bank continues to face with core inflation.

WHAT TO WATCH OUT FOR

ECB STAFF PROJECTIONS:

  • ECB JUNE 2018 HICP PROJECTIONS: HICP 1.7% in 2018 (Prev. 1.4%), 1.7% in 2019 (Prev. 1.4%), 1.7% 2020 (Prev. 1.7%).
  • ECB JUNE 2018 GROWTH PROJECTIONS: GDP in 2018 2.1% (Prev. 2.4%), 1.9% in 2019 (Prev. 1.9%), 1.7% in 2020 (Prev 1.7%)

Growth: Overall, growth forecasts are set to see little in the way of material changes as per source reports. UBS argues that there is a possibility for a minor downward revision to the 2018 2.1% forecast given the failure of Q2 EZ GDP (0.4% Q/Q) to show the rebound that some had been looking for (including the ECB) to 0.5%. However, UBS tempers this by highlighting that upward revisions to prior GDP prints could act as an off-setting factor. 2019 and 2020 growth forecasts are largely seen as unchanged.

Inflation: Inflation projections are set to come in unchanged from the levels predicted in June (as per sources) with RBC explaining that given the cut-off period for forecasts, the energy weakness seen in mid-August will lead to a lower oil price assumption than in June. Furthermore, RBC anticipate the ECB using a slightly firmer trade-weighted exchange rate but ultimately don’t see either of these changes being of sufficient magnitude to impact the inflation profile.

PRESS CONFERENCE:

In a similar vein to the previous press conference, this week’s offering by Draghi could once again disappoint those looking for volatility. With the ECB seemingly on auto-pilot mode ahead of the conclusion of its PSPP programme and not expected to move on rates until “at least through the summer of 2019”, the topics for discussion are relatively limited.

It is unlikely that journalists will use this meeting as an opportunity to grill the ECB President on what exactly “at least through the summer of 2019” means given his resistance to such questions last time around. Furthermore, Draghi will also likely take a similar approach this time to any questions about his tenure despite continued speculation over who his successor could be next year.

Naturally, a bulk of the focus for the press conference could centre around the updated economic projections, trade protectionism and general economic commentary (as discussed above) with no immediate policy decisions expected.

That said, one matter that could be a line of inquiry at the conference could be the Bank’s view on reinvestments. More specifically, with the PSPP winding down during Q4, markets will require greater clarity on the ECB’s approach to reinvestments with speculation fuelled by reports in July over a potential “operation twist” mechanism. UBS believes that the “ECB has some flexibility to extend the duration of monthly PSPP purchases to at least partially offset the PSPP portfolio maturity decay”. However, the Swiss-bank concedes that such an issue faces “implementation constraints due to issue(r) limits, limited flexibility on capital key allocation and fragmented liquidity across the EGB markets are likely to prevent the ECB from formalising a duration target for the PSPP portfolio”. Overall, SocGen do not see this as a pressing issue and ultimately “see no material policy impact from these decisions”.

Focus continues to reside on Italy with the newly-installed government taking an increasingly conciliatory tone with regards to their budgetary intentions. Despite this seemingly new approach from the populists, a clash between the nation and the EU seems almost inevitable. Such a clash would lead to grave concerns over Italy’s fiscal discipline with worries also heightened by fears over the nation’s intentions for debt held at the ECB. Subsequently, journalists will likely probe Draghi on his views on the matter and what mechanisms the Bank has to counter any potential Italian crisis. However, Goldman Sachs expect “Mr. Draghi to avoid making any direct market commentary related to Italy or Italian policy proposals. With regards to ECB treatment of Italian debt, we expect Mr. Draghi to be nonspecific and refer to the general rules already in place.

MARKET REACTION:

See below for ING’s ECB scenario analysis chart