ECB with little room to maneuver at October meeting

We should expect the European Central Bank to maintain monetary policy unchanged at the next meeting, the analysts contributing to the forecast report suggest. Economic activity in the Eurozone has been improving gradually in recent months, which is reflected in the economic data, but the recovery is still too fragile to permit monetary tightening.



In fact, some of the experts believe that there is a slight possibility of the central bank lowering interest rates from the current 0.5% level. "Should conditions in the money market tighten further, depressing activity, and weighing on inflation the Bank might act," Clemente de Lucia predicts. Alberto Muñoz believes that the ECB could make that move before the end of the year, "if things get worse" in the Eurozone.

Nevertheless, the majority of the contributing economists expect the ECB to maintain their policy unchanged in October and suggest that it will be rather Mario Draghi's post-decision press conference that will offer the markets some food for thought.

In the opinion of Alistair Cotton, the ECB president "is likely to continue to bang the forward guidance drum as loud as he can," reiterating that "rates will remain low for the foreseeable future." As Mario Draghi announced the ECB's readiness to offer banks more LTRO stimulus during his recent appearance before the European Parliament, he could repeat that option, which "could weaken the euro as it reflects economic weakness that calls for action," Yohay Elam speculates.

The ECB will announce their monetary policy decision on October 2 at 11:45 GMT. Below you will find the full forecasts of the contributing economists.

Yohay Elam - Analyst at Forex Crunch:

 "The ECB will probably leave policy unchanged at the upcoming meeting. Changing the forward guidance at this point would be pre-mature and would undermine the credibility of the central bank. Draghi could repeat the forward guidance pledge and express caution about the recovery. In his recent testimony in the European Parliament, Draghi clearly left the door open for another LTRO. While he is unlikely to introduce one at this moment, repeating the LTRO option could weaken the euro as it reflects economic weakness that calls for action. If he dismisses this option in the near future, the euro could benefit."

Clemente De Lucia - Economist at BNP Paribas:

"A) Interest rates:  According to the ECB forward guidance, the Bank will leave 'key policy rates at current or lower levels for an extended period of time'. The ECB guidance is conditional on the Governing Council view on inflation. For the time being, the Council sees the inflation outlook as subdued. Large spare capacity in the economy will continue to exert downward pressures on inflation, while energy and food prices should only add some volatility to inflation over the coming months, without altering its downward trend. Headline inflation should average 1.5% this year and 1.2-1.3% next year, largely below the ECB ceiling target for price stability. Under these conditions, the most likely scenario is that the ECB leaves policy rates unchanged over the forecast horizon.
 
Yet, although less likely, a policy rate cut cannot be completely ruled out. While at shorter maturity the excess liquidity is maintaining money interest rates at very low levels, this is not the case at the longer end of the curve, something that probably raises some eyebrows in the Frankfurt tower. Should conditions in the money market tighten further, depressing activity, and weighing on inflation the Bank might act.
 
B) Liquidity analysis: While decreasing, excess liquidity in the money market remains, keeping the Eonia close to the interest rates on deposit facility (DFR), currently at 0%. The possibility of early repayments of the two special 3 years LTROs has favored this process. However, if this process goes too far and the excess liquidity should drastically decrease, then some problems might arise.  A significant reduction of excess liquidity might dislodge the Eonia from the DFR. A rise in short term interest rates would automatically tighten monetary conditions, something that the ECB does not want at all. For the time being excess liquidity is around EUR 240 bn, that is above the threshold (between EUR 200 and 100) where some tensions might emerge. The current pace of LTRO repayments (slightly more than EUR 2bn per week on average over the last three months) does not represent a real threat in the short-term. Yet, a liquidity cliff might occur when the two special operations mature in early 2015. The ECB might, then launch another special operation to avoid a sharp reduction of liquidity and a tightening of monetary conditions."

Alistair Cotton - Senior Analyst at Currencies Direct:

"Draghi is likely to continue to bang the forward guidance drum as loud as he can at the October meeting. With the German election passing without a hitch the ECB will be looking to build on the positive momentum Angela Merkel’s victory provides, to press home that rates will remain low for the foreseeable future. We do not expect changes to the main interest rate. As such, the euro should remain pegged close to 1.35 against the USD with a lack of tapering from the FOMC countering a dovish ECB."

Steve Ruffley - Chief Market Strategist at InterTrader.com: 

"Draghi and the ECB have always maintained they still have room to manoeuvre and that they can always take additional measures when it comes to stimulus. I personally am sceptical about this and feel with the FED choosing not to reduce stimulus Draghi will do as little as he can to maintain the status quo in Europe. I think little will be said on forward guidance apart from, 'it’s not, not working'. 

With Merkel re-elected it looks like business as usual in the EU, as so much money has been spent by Germany to prop up the Euro and Euro Zone, why would it stop now? Draghi has always been a step behind the FED so I expect no real inspiration or leading from the front, I see all noises that are made to be that of a wait and see nature and Draghi desperately trying to convince the world markets that the ECB still have an ace up their sleeve with respect to forward guidance if it is needed. I for one as a trader will be looking to call that bluff soon."

Adam Narczewski - Financial Analyst at X-Trade Brokers, XTB:

"The ECB will not cut interest rates this time and far more interesting should be Mario Draghi's press conference. I expect Mario to be more dovish than usual. He should acknowledge that if he speaks in a similar tone like in September, taking into consideration what the Fed did (or has not done), it would make the EUR/USD rally towards the $1.40 level. That could put into question the recovery that is taking place in the Eurozone. The last thing the ECB needs right now is a strong Euro."

Layalee Ramahi - Strategic Manager at ICN.com:

"Hold your horses it’s not the time for the 'Big Bertha' just yet! Just as we approach the monthly meeting the market chatter becomes louder and the Governing Council led by Draghi himself play the nerve-wracking game, the war of words is still the theme and the ECB will stay on put for now assure that they are READY AND WILLING to move but not make an action now. The surprise with the Feds is not likely this meeting from the ECB but the case is similar, both need to assure stable financial markets and money market rates to preserve the signs of stabilizing and recovery. Draghi will not be overwhelmed to change the forward guidance with some positive incoming data at the macro-economic front; his eyes are on market rates, the EONIA and banks. Draghi’s reference to the possibility of a new shopping-spree for banks with cheap loans assures the monetary policy keeps track of the impact of loan repayments on the liquidity in the system; its encouraging banks are paying but they do not want to stretch their reliance on the ECB just yet. Draghi will reiterate the readiness to take action and will not be shy to be all dovish as long as it reaches the goal and withholds money market rates in place."

Ilian Yotov - FX Strategist and Founder at AllThingsForex:

"Although activity in the euro-area has been picking up, ending the prolonged recession and the chronic contraction in euro-zone's manufacturing and services sectors, the 17-nation economy is still struggling with record high unemployment. The European Central Bank will not tighten monetary policy anytime soon in this environment and will probably echo the message that policy will remain accommodative 'for the foreseeable future.' The USD should be able to regain its strength against the EUR if the U.S. labor market data improves and the Fed gets ready to take the first step towards monetary policy tightening while the European Central Bank remains stuck in an easing mode."

Valeria Bednarik - Chief Analyst with FXstreet.com:

"Ever since the European Central Bank established the forward guidance, Mario Draghi seems to be more comfortable with current economic policies, leaving little room for changes in the upcoming meeting. Inflation is far from becoming a concern and with latest data suggesting the EU is finally emerging from recession, I would expect an on hold stance for October. If something, Draghi speech may bring some action, although I would expect limited market reactions this time."

Alberto Muñoz, Ph.D. - Forex Analyst at FXstreet.com:

"ECB president Mario Draghi kept a clear dovish tone in September meeting, so I would say nothing is going to change this time either. Draghi remains bearish on growth in the Eurozone and probably he's even considering a rate cut by the end of the year if things get worse. Anyway I don't think Draghi will actually cut rates in the next months as many PMIs and other business indices such as German Ifo are showing a slight improvement in business conditions across Europe."