Taking stock

The ECB meeting next week (21 January) is set to be anuneventful one. We largely expect it tobe a stocktakingmeeting without anynew policy signals. As theeuro area economy isstillin lockdownand is likely to be through all of Q1, the services sector is set tocontinue to drag the economylower, but with the rollout of the vaccines and improvement in the weather conditions, economic activity is set to pick up. We expect this ray of optimism (as well as the approval of the Recovery Fund) tobe conveyed atthe press conference.

The recalibration of the ECB’spolicy instruments in December has been well absorbed by markets, which means there is no urgency for the ECB to signal a new policy stance. We expect the ECB to refrain from commenting on apotential taper discussion, which has started in the US.

The ‘new’ enforced flexible implementation of the PEPP will keep financing conditionsand bond yields low. We do not expect markets to react strongly to the press conference (Bunds within 2bp) and continue to be comfortable with the -60bp to -40bp German Bund range in the near future. We expect the ECB tocounteract any sell-off or steeper curves in anticipation of improvementsin the economic data. There isa clear difference between the UST and the EGB outlook and 10Y US-DE spread widening should be in scope to around 200bp (from current 164bp) this year. The ECB’s view of being onhold is neutral for spot currency.Near term, Italian politics could potentially bog down the EUR but for now,we view this as a non-event from a currency perspective.

Focus on the Q&A session

We have only had very few ECB GC speakers on the wires since the last monetary policy meeting in December. On Tuesday, ECB board member Schnabel conveyed that a mechanical increase of the inflation outlook will not change the monetary policy stance,while on Wednesday, ECB president Lagarde said that the current staff projections from December are still ‘very clearly plausible’. This means that thefocus next week is expected to be on the Q&A, although we expect this tobe relatively uneventful as well.

Fed tapering discussion. While some FOMC has opened the discussion on potential changing/tapering the bond purchases, we expect Lagarde to dismiss any such idea. With the PEPP envelope of potential net purchases until March 2022, the embedded flexibility allows ECB to implicit taperpurchases without an actual announcement. This is our base case for when it happens, but this is clearly premature now.

FX. We expect Lagarde to repeat the awareness of the FX developments and repeat that it feeds into theinflation outlook, without further commenting on this. She will signal readiness to act,while repeating that FX is ‘not part of the mandate’.

Inflation outlook. We expect the ECB to look through the mechanical upswing ininflation,as its mandate is‘oriented towards a medium-term horizon’.

Strategic review. We do not expect new signals for the strategic review. Lagarde said on Wednesday that the ECB isabouthalf way on the review.

Nevertheless, while disagreement has been visible in the GC for the first time since Lagarde took office one yearago, we expect the ECB GC to keep its backstop option to the economy.

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