- Ongoing French elections to overshadow ECB meeting
- ECB doesn’t want to create extra volatility and Draghi will keep lips sealed
- Therefore, no major policy changes or tweaks in communication Risks to outlook upgraded to broadly balanced from tilted to the downside
- Slight tweak in Forward guidance (diminishing possibility of lower rates?) possible, but unlikely
- Major decisions likely at September meeting, with signaling of intentions in June
The ECB meeting on Thursday takes place in between the two rounds of the French presidential elections. So, we expect the ECB to refrain from giving important new information on its policy outlook. It doesn’t want to risk adding unnecessarily to uncertainty and volatility about its future intentions or actions at a time of particular market sensitivity. In any event, there is little economic rationale for the ECB to alter its now well‐worn message. It has no new economic and inflation projections and the recent March inflation data surprised on the downside for both headline and core readings. These circumstances allow and encourage the ECB to take its time and await the right moment to eventually change policy. So, we expect ECB president Draghi to confirm the continuation of all major elements of the current policy stance. This entails continuing asset purchases till at least the end of 2017 or beyond, if necessary. Forward guidance will continue to suggest that rates might stay at current (or lower) levels for an extended period of time and well past the end of the asset purchases.
While the ECB is expected to emphasise continuity, there may be some subtle indications that circumstances are changing albeit gradually in a manner that in time will have more significant implications for policy. In this context, two points are open for debate in terms of this week’s policy statement; Will the ECB in its forward guidance still keep the option that rates may be lowered further and, consistent with that possibility, will it continue to see downside risks to the growth outlook?
Minutes March meeting: Easing bias
The starting point for the discussion on Thursday’s ECB meeting may be suggested by the recently published summary of the Minutes of the March meeting. These revealed that there ‘was broad agreement’ on the Governing Council that the outlook for activity had improved and that downside risks had receded. This prompted a debate about whether a softening of the ‘easing bias’ in the Bank’s forward guidance was warranted. Governing Council members felt that a discussion of policy normalisation ‘would be warranted in the future’ if growth and underlying inflation increased.
It was decided that it would be ‘premature’ to remove hints about possible further easing because this ‘could lead to an undue upward shift in market interest rates and tighten financial conditions’. There was also a consensus view that current plans to buy €60bn of assets per month throughout this year were appropriate. And the minutes reiterated that purchases would continue for longer if underlying inflation failed to pick up.
Economic recovering strengthens, while inflation unexpectedly dropped
Business surveys for the euro‐zone released in the past week that relate to April were very encouraging. The flash composite PMI rose to a six‐year high, reflecting improvements in both the services and manufacturing sectors. It means that not only Q1 activity continue to grow above trend, but it suggests that the economy is still accelerating at the start of Q2. It might lead to upward revision for growth in 2017 and beyond in the June ECB staff projections. Possibly even more encouraging, economic activity is broadening with the German economy possibly slightly slowing, but with accelerating growth in countries like France and Italy that until recently had been large and problematic laggards in the recovery. Finally, it should please the ECB that the manifold political risks inside and outside the euro area haven’t had any discernible negative impact on the European economy at least to this point.
Inflation disappointed in March with the headline HICP dropping to 1.5% Y/Y, after having briefly touched 2% Y/Y in February, while the core inflation fell back to 0.7% Y/Y from 0.9% Y/Y. This release certainly gives the ECB grounds to argue that inflation is not on a sustainable path towards the 2% objective and, by extension, substantial monetary accommodation continues to be required. Without going into too much detail, the decline doesn’t seem particularly worrisome to us and is the result of some special factors like energy and food that pushed inflation higher (than expected) in the winter months and are now reversing In March, the decline was driven by lower energy and food prices, but also by a number of service prices that were affected by the late timing of Easter this year compared to last year. The holiday package price evolution is the best known example. Therefore, we expect inflation and core inflation to have moderately rebounded in April (to be published on Friday).
Changes in FG and risk assessment
In the light of these elements, we think the ECB will now see risks to the growth outlook as being broadly balanced instead of tilted to the downside. ECB executive member Coeuré argued in favour of such a change two weeks ago.
A small change in the forward guidance is not excluded either. More in particular the ECB may drop the reference to ‘lower rates’. That reference is long overdone. First, deflation risks have disappeared and second, from a fundamental point of view, the current ‐40 basis points depo‐rate is considered by many governors and still more observers as a kind of lower boundary beyond which negative effects outweigh positive ones. However, the ECB may strategically and tactically want to wait for a more thorough examination and discussion of its forward guidance at the June meeting, when French presidential elections are over and new projections are available. A fuller consideration at that point would emphasise that the ECB is not mechanically responding to the vagaries of monthly releases but is instead carefully refining its view of any emerging changes to the policy relevant medium term outlook.
Exit crisis policy stance coming closer
While we don’t expect much by way of fireworks this week, we think that the June and September ECB meetings will be crucial to an eventual but carefully prepared shift in the stance of ECB policy. In June, we might see the ECB rework its forward guidance to bring it more in sync with the current economic reality of healthy and increasingly broadly based gains in activity employment.
That could set the stage for crucial decisions in September on the exit policy from the current unconventional setting (QE/negative rates). At the September meeting, we might see the ECB recalibrate again its QE and reduce the monthly amount of asset purchases further, perhaps to €40B, but at the same time prolonging QE into 2018 which would see the further tapering and the eventual ending of asset purchases.
A further recalibration as early as September might be presented as giving the ECB more space to prolong the period of purchase programme as technical hurdles to its smooth continuation in the form of a growing scarcity of eligible assets will steadily increase. The issue and issuer limits in the asset purchases framework are becoming a binding hurdle to buy bonds of an increasing number of countries
In this regard, the ECB SESFOD survey of financial markets for the first time mentioned deterioration of conditions in various markets due to the asset purchases. It mentioned worsened market liquidity for underlying collateral, less favourable non‐price terms for secured funding and for non‐cleared OTC derivatives. ‘The tightening of credit terms was more pronounced with respect to non‐price terms than for price terms. Also, overall credit terms for secured funding tightened year‐on‐year when government bonds, high‐yield corporate bonds or equities were used as collateral. Survey respondents also reported less favourable non‐price credit terms applied to OTC derivative counterparties relative to one year ago, in particular in the case of interest rate and foreign exchange derivatives.’
While we don’t expect any clear signals in relation to the asset purchase programme this week, we will be particularly attentive to any part of the Q&A session that hints the matter may be receiving serious attention at present in Frankfurt. Policy and technical considerations mean we think that the ECB will need to signal a notably diminished amount of bond purchases before the end of the year. We also think that the first rate hike will take place before end 2018 and that they will speedily bring the depo‐rate to zero.
We don’t expect any significant first step to be signalled at this week’s ECB meeting but there may be hints that behind the scenes plans for an eventual exit path from the current exceptional monetary stance are at least starting to be discussed.
