The European Central Bank’s next monetary policy meeting is scheduled for June 8th, 2017. The ECB’s meeting gains prominence amid a broad-based pickup in the economic recovery in the eurozone. This puts in focus on how the ECB will deliver its assessment this week.
Earlier last week, speculation was rife that the ECB could begin to prepare the markets for a possible tapering to its QE program later this year. Most likely in during the September meeting.
The possibility of a tightening bias saw the euro rally on the news, only to fade later in the day.
The euro currency has been posting steady gains ahead of time. The rally started right after the conclusion of the French presidential elections. As the political risks faded, the euro turned the focus on the possibility of tightening from the European Central bank.
Why is the ECB expected to be hawkish at the June meeting?
The economic activity in the eurozone has been continuing with the pickup seen gaining momentum. In the first quarter, the Eurozone’s combined gross domestic product (GDP) rose 0.5% on a quarter over quarter basis. Annualized, the GDP rose 1.7% compared to the same quarter a year before.
Figure 1: EA19 and EU28 GDP QoQ and YoY (Source: Eurostat)
Inflation, which was one stubbornly low also managed to rise 1.9% on the headline in April, while core inflation rose 1.2% during the period. The gains in April came following a 1.5% increase in March. Of course, most of the gains came from higher energy prices which rose 7.6% on the month, advancing from 7.4% the month before.
The services sector also added to the increase, accelerating 1.8% on the month, up from 1.0% from the previous month.
The increase in inflation and GDP obviously prompted lawmakers from Germany and Netherlands to put pressure on the ECB to tighten monetary policy.
As a result, the speculation of tightening sent the euro higher.
While data remains positive, there is no denying the fact that there is no strong evidence that inflationary pressures are here to stay.
Why could the ECB disappoint the markets this week?
Last week’s flash inflation estimates from Eurostat, however, showed that inflation eased back in May. According to the flash estimates, official data showed that headline consumer price index fell in May, compared to April.
Headline consumer prices rose 1.4% on an annualized basis, down from April’s 1.9% increase. Core consumer prices which strip the volatile food and energy prices also slipped, rising just 0.9%, down from 1.2% increase registered in April.
As expected, energy prices eased, rising 4.6% compared to the 7.6% increase registered in April. While food prices rose 1.5%, rising at the same pace as the month before, services also eased, rising 1.3% compared to 1.8%.
Draghi: Still too early to tell if inflation is self-sustained
Last week, despite the hawkish speculation, ECB President Mario Draghi was testifying to the European Parliament in Brussels. He told lawmakers there that it was too early to tell whether inflation was in a "self-sustained upward adjustment."
Draghi’s comments suggest that there is a possibility for the ECB to do nothing. Given the divergence with the expectations, this sets the possibility of a disappointment in the markets.
But remove the inflation aspect from the puzzle, and the other economic indicators point to sustained growth. This will likely see the ECB to remove some of its dovish assumptions when it meets this week.
But, it is going to be a balancing act as far as the ECB is concerned.
So, what will the ECB do at the June meeting?
Most likely, the ECB will give a positive assessment of the economy as far as growth is concerned. This could be sensed as the central bank being hawkish. As for the market expectations on QE tapering, Draghi is likely to remain cautious on inflation.
After all, it is much better for the central bank chief to bear the ire of lawmakers in the eurozone than to make a policy mistake and risk the ECB’s credibility.
Any concrete forward guidance on policy tightening will have to wait for now.
In conclusion, the risks to the euro remain to the downside for the moment. It will all come down to how the markets will interpret the ECB’s meeting next week.
