ECB preview: Inflation top of the agenda

• At the ECB meeting the most important topic will be inflation, which is much lower than the ECB’s 2% target.

• Mario Draghi is likely to be dovish and signal that he will act to ensure that medium-term inflation expectations remain ‘anchored’ if needed.

• A rate cut will be discussed and even though it is not our main scenario, it is possible the ECB will react quickly to the low inflation rate. We expect the ECB to cut the refi rate in December when new forecasts are released.

• Excess liquidity continues to decline and money market rates have been slowly pushed higher. The ECB does not like de facto monetary tightening and looking ahead it is likely it will act by using non-standard measures.

• The market has built up expectations of the ECB, but the pricing does not give a clear answer on the probability of a refi cut versus providing liquidity. For the November meeting some probability of a refi cut is also priced in.

Inflation to get almost all of the attention

Inflation in the euro area was down at 0.7% in October, which is much lower than the ECB’s target of maintaining inflation below but close to 2% over the medium term. Hence, it is likely to get almost all of the attention at the ECB meeting on Thursday. We expect Draghi to be very dovish when talking about the development in inflation and send a strong signal that he will act to ensure that medium-term inflation expectations remain ‘anchored’. Looking ahead, we expect the ECB to cut the refi rate by 25bp at the ECB meeting in December.

The inflation rate of 0.7% in October was not a one-off and the likelihood that Draghi will describe it as transitory is limited. The lower rate followed as energy prices declined more than in September, food prices increased at a slower pace and also core inflation increased less than in the preceding month. The decline in core inflation was due to a slower increase in service prices. This is largely explained by high unemployment and the associated low wage pressure due to the high dependency of labour as an input in the service sector. The development in energy and food prices can to a large extent be explained by the end of the super-cycle in commodity prices.

Even in the introductory statement we expect Draghi to be much more dovish on the inflation outlook. He might exclude his comment that there is an upside risk to the outlook for price developments ‘relating in particular to higher commodity prices’. However, he could wait until the December meeting when we expect a rate cut.

Discussion of a rate cut

The ECB Governing Council will definitely discuss a rate cut at the November meeting and even though it is not our main scenario, it is possible that the ECB will respond quickly to the low inflation and cut the policy rate this week. In our view, it will use this meeting to signal a rate cut in December.