ECB: New complications on the road to taper - ING

Carsten Brzeski, Chief Economist at ING, suggests that even though we still have three more weeks to go before the next ECB meeting, recent developments clearly signal doing nothing and buying time in June is the best and most risk-free option.

Key Quotes

“With a fresh update of staff projections, the ECB could have sufficient substantial input to unveil first details of the next QE steps at the June meeting or so many market participants at least say. The reality, however, could look differently. In our view, new uncertainty on the back of weaker economic data, higher oil prices and Italian politics argue in favour of buying more time.”

“A quick look at the three main economic challenges the ECB will be facing at the June meeting.

1. Soft patch vs downswing

At face value, the growth slowdown in the first quarter was mild enough to be filed away as a “soft patch” instead of a “downswing”. Economic fundamentals have also not changed over the last few months. However, soft indicators have not yet recovered, the fading eu(ro)phoria could dent further optimism, and the external environment has become a risk rather than an opportunity.

The problem ECB forecasters are currently facing is that very little new hard data will become available between now and the cut-off date of the forecasts or the June meeting. In fact, except for soft indicators for May and hard data for a couple of Eurozone countries for April, no other guidance will be available. Probably too little for the ECB to take a clear position in the soft patch versus downswing discussion. Consequently, we expect the ECB to stick to its positive take on the Eurozone recovery, but at the same time stressing increased uncertainty and the need for more evidence.

2. The double-edged sword called oil

The surge in oil prices since the beginning of the year is probably the single biggest problem for the ECB. Since February, oil prices have increased by more than 20%. Add the effect of the weaker euro exchange rate, oil prices denominated in euro have increased by almost 30%. As so often in the past, higher oil prices are a double-edged sword for the ECB.

On the one hand, higher oil prices could dent the recovery (according to our back-of-the-envelope estimates, higher oil prices could allow one-third of the wage increases in Germany evaporate in thin air). On the other hand, they should push up the ECB’s inflation projections.

At the same time, GDP growth forecast could be revised downwards by some 0.2 percentage points. All of this means that only due to changes in the technical assumptions, a benign outlook for headline inflation could quickly become a close-to-target forecast.

3. Italian politics

Obviously, Italian politics is the new kid on the block when it comes to challenges for the ECB so don't expect ECB president Mario Draghi to comment on this. At best, he could give some very general remarks on how the ECB looks at the idea of mini-BoTs.”

“Buying time in June looks like the most risk-free option

In our view, the unconcluded debate on soft patch versus downswing, the surge in oil prices and recent political developments in Italy clearly suggest doing nothing at the June meeting is the best and most risk-free option for the ECB. The only thing Draghi could do is to reconfirm his earlier statement that he does not expect an abrupt end to QE in September, opening the door for an extension.”