- Draghi signaled that growth peak might be behind us
- A lot of questions on ECB Nowotny’s slip of the tongue
- No policy changes; expectations are low
- Risk for more optimist/hawkish tone in communication?
Status quo in March
The March ECB policy meeting saw a small step on what promises to be a long journey towards policy normalization but any possibility that this might prompt significant adverse market reaction was more than countered by the very dovish wording emphasised by Mario Draghi in explaining the change in the ECB’s thinking.
The ECB opted to remove a commitment to increase the scale or duration of the Asset Purchase Programme in the event of a deterioration in economic or financial conditions at the previous policy meeting in March. This small change in forward guidance didn’t come as any surprise because of the strong EMU growth performance. Moreover, the removal of the easing bias was balanced by comments from ECB president Draghi and new ECB economic projections arguing in favour of keeping in place an ample degree of monetary stimulus.
Mr Draghi reassured markets by underlining that a very accommodative policy stance will remain necessary if underlying inflation pressures are to build to the point where they support headline inflation developments moving towards the ECB’s target of below but close to 2% over the medium term. Current ECB forecasts project headline CPI at 1.4% this year and in 2019, before accelerating to 1.7% in 2020.
The recently released minutes of that March meeting pointed out that some governors put forward the view that enough progress had already been made to put inflation on a sustained path towards the medium‐term policy goal of just under 2%. This possibly important signal eventually didn’t feature in the ECB’s statement. The bloc around the architects of the current extraordinary monetary policy – President Draghi, Vice‐President Constancio and Chief Economist Praet – still holds the majority and is still of a more dovish disposition. They argue that sufficient slack remains for the EMU economy to grow without exerting upward price pressure and appear to take the view that premature policy tightening or comments that prompt a tightening of financial conditions by markets anticipating aggressive ECB action are risks the ECB must avoid at present.
A second notable highlight of the account of the March 7‐8 meeting was widespread concern about a potential trade war: “the risk of trade conflicts, which could be expected to have an adverse impact on activity for all countries involved, had increased.” ECB president Draghi strengthened this view in recent comments by pointing out that positive developments in the euro area are not independent of the global growth momentum. “Preserving openness is crucial if the global economy is to thrive and to secure its growth potential.”
EMU growth peak behind us?
Draghi warned in that same speech at the International Monetary and Financial Committee (Apr 20) for the first time that latest EMU economic indicators suggest that the growth cycle might have peaked (in Q4 2017), even if growth momentum is expected to continue. PMI’s seem to underwrite that view of a natural tipping over of the economic cycle. The EMU composite PMI peaked in January at 58.8. The latest, April reading, showed a stabilization at 55.2 after two consecutive declines in February and March. That’s close to the three uninterrupted drops which are considered as a change in trend. Other confidence indicators, as well as hard data, at least tentatively point in the same direction.
The slight tweak in growth rhetoric was accompanied by confirmed confidence in the inflation outlook. Underlying inflation is expected to rise gradually supported by the ECB’s monetary measures and in line with the ongoing reabsorption of economic slack and rising wage growth. Last week’s German public sector pay deal, following the agreement reached by IG Metall earlier this year, is at least a pointer towards a rising trend in domestic costs in some parts of the Euro area economy. However broader and sustained evidence of rising costs may be needed to confirm that a persistent pick‐up in inflation is in sight.
Without reading too much into it, the slight shift in the tone of recent comments could be interpreted as signaling a growing awareness on the part of at the ECB of an argument in favor of policy normalization stemming from the need to build in room to act in the event of a future downturn. The Fed in more or less similar vein turned the argument at the start of the normalization process. Initially, they focused on the lack of actual inflation pressure despite US growth momentum. That thinking subtly shifted to confidence that US economy became strong enough to expect inflation to pick up.
Market expectations are low
There is little prospect of any substantive changes to the ECB’s forward guidance or monetary policy this week. In the absence of such developments, any slight shift in tone could be the most important thing to watch at Thursday’s ECB meeting. From a market point of view, it suggests that risks are marginally tilted to the hawkish side because expectations going into the meeting are very low. Consensus has been building that the ECB will end its net asset purchases by the end of the year, but communication on the issue will probably only come in June (with new growth/inflation forecasts) or, as hinted in recent ECB ‘sources’ newswire reports, in July. Current economic conditions still warrant a first ECB rate hike by mid‐2019, in line with what president Draghi flagged during the Q&A after one of the previous press conference. The (rate) market remains more dovish positioned, only expecting positive 3m Euribor rates by the end of 2019.
While it is unlikely to feature in the ECB’s opening press statement, an important feature of this week’s meeting could be a focus in the Q&A session on the Austrian central bank governor Nowotny’s April 10 Reuters interview. Nowotny suggested a 20 bps deposit rate hike was feasible shortly after the ECB ends its net asset purchases, narrowing the interest rate corridor. Subsequently, the ECB could hike its main policy rates simultaneously. Nowotny is the first governor to give any detail on the practical stages entailed when the ECB moves onto a normalization path, even if the ECB officially distanced itself from his views. Markets proved to be sensitive to the issue with higher (short term) European rates and a stronger euro as a consequence. The official ECB stance on the issue remains rather vague, hanging on to the broader idea of a sequencing” principle: first ending net asset purchases and next start hiking interest rates. We expect Draghi to hold on to that official line for now.
The market expects little excitement from the ECB this week and reaction to what is likely to be little more than a repeat of previous commentary will probably be muted. The recent negative momentum on bond markets suggests that a sell‐off might continue if Draghi deviates slightly from the dovish scenario that markets have in mind. From a technical point of view, we initially eye a return towards the 0.80% 2018 top in the German 10‐yr yield. The euro could be less sensitive on this stage as long as Draghi doesn’t elaborate on the post‐APP period. A more optimistic ECB could nevertheless slow EUR/USD’s downward momentum and complicate a test of first support at 1.2215/1.2155.
