ECB: More, If Needed

Published on August 31, 2015

The European Central Bank Monetary Policy Committee meeting this Thursday, September 3, will be scrutinized closely as it will include the release of revisions to its Quarterly Staff Economic Forecast that often coincide or lead to monetary policy changes.


That scrutiny has been all the more heightened by warnings last week from ECB Chief Economist and Executive Committee member Peter Praet of the potential for downward revisions to these forecasts.


*** We expect ECB President Mario Draghi to strike a dovish tone at Thursday’s meeting in forcefully reiterating the Committee’s willingness to take further action – if needed – to fulfill its still elusive 2% or slightly below inflation mandate. But he is unlikely to signal any new expansion of the current quantitative easing program. ***


A few points to highlight:


** We expect Draghi’s comments will include an express readiness to counter any undue “externally” induced tightness in monetary policy conditions, be they stemming from expectations of rate hikes in the United States or from an unusual strengthening of the Euro currency exchange rate.


** Even though the staff forecasts will need to be revised downward somewhat to account for weaker than anticipated oil prices – not just for 2015, but along the curve for 2016 and to a lesser extent 2017 – we believe Draghi and the ECB will also go out of their way to distinguish between the energy-driven headline inflation figures, including the just released 0.2% reading, and core inflation, which has been holding up far better if not improving, with the latest reading at 1%.


** The ECB had been expecting CPI to remain so low only through the first part of the year, but the low inflation has in fact persisted for longer than hoped and looks to stay stubbornly low into the Autumn months.


** On the other hand, low energy prices are expected to feed through into a positive demand effect on real disposable income for the Eurozone consumer. That will allow the ECB to “look through” the low inflation prints — as long as there is no evidence it is also feeding into a more significant drop in inflation expectations.


** If and when the Governing Council were to decide further action is needed – which again we do not expect at this meeting – the easiest route to consensus would be an extension of the QE program beyond its currently scheduled September 2016 end date, a contingency option that was already pre-agreed to by the Committee when the QE program was rolled out in January this year.


** An increase in the rate of monthly bond purchases from an average of 60 billion Euros per month, or a front-loading and acceleration of the planned purchases, is also possible. But either would require a higher bar to enact, given the already extremely low and well controlled Eurozone short rates and expectations along the strip, as well as higher political and operational challenges to enacting additional bond purchases.


** We therefore expect Draghi to remain cautious at this meeting in steering clear of any premature signaling that additional purchases could be imminent or flagging any imminent broadening of purchases to other asset classes such as corporate bonds. While possible, those bullets will be kept dry and in reserve for if and when needed. Draghi will instead be sure to highlight the effectiveness of its Asset Backed Security bond purchase program.


** For all the Eurozone’s inflation challenges, we expect Draghi to also strike a modestly upbeat tone on the Eurozone growth prospects and recovery. While the impact of a potential further slowdown in China remains as much of a wild card for the Eurozone as it does for the US, and indeed global economy, the European growth data has been encouraging, with Germany and many other Eurozone countries, including Spain, recovering smartly.

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