Carsten Brzeski Chief Economist at ING, expects this week’s ECB meeting to be a double balancing act for Mario Draghi and his colleagues as the ECB wants to prepare financial markets for tapering, without creating a taper tantrum, while at the same time finding economic arguments supportive of tapering despite low inflationary pressure.
“The general macro picture in the Eurozone has not changed since the ECB’s early June meeting. Confidence indicators remain strong, despite some recent downward corrections. Activity has picked up further but inflationary pressures are almost impossible to find. If anything, the drop in oil prices, the pick-up in bond yields and the strengthening of the euro have further – at least technically – deteriorated the ECB’s inflation outlook.”
“More generally speaking, the ECB will continue facing very little homemade inflationary pressures. There are reasons to believe that wage growth in the Eurozone is bound to stay lacklustre: slack in the labour market, sectoral and technological changes all argue against a fast pick-up in Eurozone wage growth; even with GDP growth above trend growth. In addition, digitalisation, as long as it continues to increase in importance, both in B2B and B2C, is likely to apply downward pressure on consumer prices due to higher price transparency and more competition, now also in services.”
“Given the latest bond market developments, the ECB’s macro assessment will not be the main item of this week’s meeting. A possible unwinding of QE – tapering – is at the top of the mind of all market participants and ECB watchers. We believe that given the cyclical upswing, the disappearance of deflationary risks, opposition against QE from some ECB members and the bond supply scarcity issue, the ECB wants to move towards tapering. However, the ECB ideally would like to prepare markets without distorting them.”
“In this process to move towards tapering, the absence of any inflationary pressure makes the narrative a bit complicated. This is why Draghi tried to adjust the official communication and line of argumentation; away from inflation towards a new concept of a monetary policy speed limit. In this context, the key phrase in Sintra was ‘As the economy continues to recover, a constant policy stance will become more accommodative, and the central bank can accompany the recovery by adjusting the parameters of its policy instruments – not in order to tighten the policy stance, but to keep it broadly unchanged’. The ideal new narrative for the ECB to prepare tapering.”
“Over the last months, ECB President Draghi has introduced several key words and concepts. Just think of the four inflation criteria (not transitory, durable, self-sustained and broad-based), wages as the ECB’s lynchpin and now recently persistence, prudence and the monetary stance with stronger economic growth.”
“In our view, all attempts to moderate the path towards tapering without distorting markets. Obviously at the risk of giving less, instead of more, guidance. In our view, the ECB’s tiptoeing towards tapering will continue this week and we expect Draghi to repeat the key messages from the Sintra speech. More hawkish signals could come by dropping the easing bias for QE, by saying “we stand ready to increase our asset purchase programme in terms of duration (and not size)”. This is a move which in our view would be too hawkish. In particular, the reaction of bond markets over the last two weeks, however, has been a good reminder of how thin the line is between preparing markets and distorting them. Some steepening of the yield curve is fine, a real taper tantrum is not. This is why some dovish remarks by Draghi should not be excluded. The best way to do this would be by stressing sequencing, ie, dropping clear hints that a first interest rate hike will not come before the end of QE. All in all, a balancing act that requires all of Draghi’s verbal acrobatic skills.”
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