ECB Preview: A Trapped Mario Draghi Makes A Decision
After a barrage of media trial balloons (as recently as today) meant to temper the enthusiasm of Euro bulls now that the EURUSD is back to 1.20 and threatening European corporate profitability, Mario Draghi’s Sintra hawkishness is a distant memory.
And so, with the ECB’s policy decision less than 12 hours from now, a “trapped” Mario Draghi finds himself in a quandary: with less than 4 month left until the formal expiration of the ECB’s €2.3 trillion QE program, he will likely start laying the groundwork for the central bank’s stimulus reduction – after all the ECB is rapidly running out of bonds to purchase – but without revealing too much as that will send the EUR surging, and he will also hold off on any major commitment, as an explicit backing off his recent hawkishness could collapse the EUR and send Bunds right back into NIRPatory.
Which path will he take?
With that in mind, courtesy of RanSquawk, here is a full preview of what to expect (or not) from the ECB president tomorrow.
Rate Decision due at 1245BST/0645CDT and Press Conference at 1330BST/0730CDT
- All rates and the current pace of asset purchases are expected to be left unchanged
- Staff will update macroeconomic projections; impact of EUR likely to weigh on inflation outlook
- Key focus for press conference will be on recent EUR strength and possible QE exit
- Click here for a link to an overview of ECB rhetoric since the last meeting
RATE/ASSET PURCHASE EXPECTATIONS
- DEPOSIT RATE: Forecast to remain unchanged at -0.40%. The rate was last adjusted in March 2016, when it was cut by 10bps.
- REFI RATE: Forecast to remain unchanged at 0.00%. The rate was last adjusted in March 2016, when it was cut by 5bps.
- MARGINAL RATE: Forecast to remain unchanged at 0.25%. The rate was last adjusted in March 2016, when it was cut by 5bps.
- ASSET PURCHASES: Forecast to maintain the pace of asset purchases at EUR 60bln per month until December 2017. Last December, the ECB reduced the size of purchases by EUR 20bln per month, and extended the purchase horizon by nine months.
CURRENT ECB FORWARD GUIDANCE
- RATES: “The Governing Council continues to expect the key ECB interest rates to remain at present levels for an extended period of time, and well past the horizon of the net asset purchases.” (ECB statement, 20/Jul)
- ASSET PURCHASES: “Net asset purchases, at the current monthly pace of €60 billion, are intended to run until the end of December 2017, or beyond, if necessary, and in any case until the Governing Council sees a sustained adjustment in the path of inflation consistent with its inflation aim.” (ECB statement, 20/Jul)
- GROWTH: “The risks to the growth outlook are broadly balanced.” (ECB statement, 20/Jul)
- INFLATION: “While the ongoing economic expansion provides confidence that inflation will gradually head to levels in line with our inflation aim, it has yet to translate into stronger inflation dynamics. Headline inflation is dampened by the weakness in energy prices. Moreover, measures of underlying inflation remain overall at subdued levels. Therefore, a very substantial degree of monetary accommodation is still needed for underlying inflation pressures to gradually build up and support headline inflation developments in the medium term.” (ECB statement, 20/Jul)
POTENTIAL ADJUSTMENTS TO FORWARD GUIDANCE/ROADMAP TO EXITING LOOSE POLICY
- RATES: No adjustments expected
- ASSET PURCHASES: Consensus is for no change expected to exact phrasing above. Commerzbank suggest ECB could add ‘or at a lower pace’ into the above statement.
- GROWTH: No adjustments expected (although impact of firmer EUR could be reflected in latest economic projections).
- INFLATION: No adjustments expected (although impact of firmer EUR is expected to be reflected in latest economic projections).
Given the EUR’s 13% advancement against the USD this year, a key focus of the market’s view on ECB monetary policy has been on the appreciating currency. Despite this ultimately reflecting a resurgence in the Eurozone economy, the ECB will be wary of the potential impact on the Eurozone’s inflation path. As such, markets will be looking to see if Draghi talks down the currency with recent source reports (Aug 31st) highlighting EUR is worrying a growing number of ECB policymakers, adding that EUR concerns increase chance of delay in QE decision, or a more gradual exit from asset purchases. Furthermore, the minutes from the previous meeting also highlighted concerns about overshooting and as such given Draghi’s decision to not comment on the currency at Jackson Hole, markets will be highly sensitive to any potential verbal intervention by the President. **Note that existing rhetoric states ‘the ECB does not target the exchange rate’.* *
That said, ECB’s Nowotny (Sep 1st) has warned markets not to over-dramatize EUR gains vs. USD and ECB’s Hansson (Aug 23rd) also came out and downplayed the issue last month. Despite Hansson and Nowotny being two of the more hawkish policymakers at the Bank and thus in-fitting with their stances, it highlights a lack of unanimity at the ECB.
FUTURE PATH OF QE PROGRAMME
Aside from the firmer EUR, another key source of focus for the market will be on any clues as to when the ECB could begin tapering its QE programme given recent economic developments and concerns over bond scarcity. Ultimately, consensus amongst analysts suggest that this meeting will be too early for the bank to outline its plans for tapering at this stage with October seen as a more likely platform for the ECB to provide concrete policy actions; a view back by last month’s (Aug 16th) ECB source reports that suggested the council will hold off on debating the issue until Autumn. Furthermore, the minutes from the July meeting revealed the aim to ‘gain more policy space and flexibility to adjust policy and the degree of monetary policy accommodation, if and when needed, in either direction’; thus suggesting that the central bank will continue to hold off; as highlighted by Lloyds. Commerzbank also highlight the issue of bond scarcity given the current pace of monthly purchases which could cause a headache for the bank. However, Commerzbank suggest that it is unlikely the ECB would be willing to raise the limits on purchases from individual issuers and as such scarcity will have to be addressed as part of a larger policy move.
Although no explicit announcements are expected this time round, Nordea expect the ECB to comment on the preparatory work on September 7th, subsequently hinting at a decision on October 26th. However, Pictet suggest that markets may have to wait potentially longer than October with the ECB looking to avoid a disorderly exit from policy by proceeding in a cautious manner. This would be achieved by eventually scaling down purchases (avoid explicit mentioning of tapering), no mentioning of ending asset purchases initially or referring to actions as outright monetary tightening. Although it is likely that few details will be revealed during this meeting regarding how the ECB will manage their exit from current policy, the above is worth noting if Draghi et al elude to potential announcements next month.
ECB STAFF MACROECONOMIC PROJECTIONS
INFLATION: Likely to be downgraded given the appreciation of the EUR with June projections made under an assumed rate of 1.09 in 2018-2019. Nordea expect the new assumed rate to climb to 1.18 in 2018-2019 and as such, would imply lower annual inflation in 2017-19 by 0.1-0.3% points. However, Nordea also highlight that improving employment prospects in the Eurozone (which could imply higher wages) and the future oil profile could limit the extent of inflation downgrades.
REAL GDP: There is potential for 2017 growth to be upgraded given recent firm PMI data and consumer confidence, according to Nordea. However, Pictet suggest that longer-term forecasts are likely to be little changed given the possible headwinds of the firmer EUR with ING’s base case for downward revisions for 2018/19 amid FX effects.
In terms of a potential market reaction, given the focus on EUR appreciation, FX markets will be mostly centred around any potential verbal intervention by Draghi on the currency. If Draghi is overtly cautious on recent EUR strength this will likely lead to pressure on EUR, whereas, if Draghi downplays the bank’s focus on targeting the FX rate this could provide further fuel to the EUR rally. Elsewhere, the other main source of traction will be hints on when the ECB will curtail bond purchases. It is likely that Draghi won’t offer too much on this front. However, if details are provided or Draghi is forceful about a potential unveiling of details next month, this could lead to selling pressure in fixed income markets, equities and upside in EUR. Furthermore for fixed income markets, traders will also be looking out for any potential reference to the bank’s view on bond scarcity and any possible measures which could be used to counter this issue. However, such actions are unlikely to be made this time round.