Key points from ECB statement and press conference

  • ‘Bulk’ of QE decisions to be taken at October meeting
  • EZ growth stable and broad based - GDP outlook revised up to 2.2% in 2017, best growth since 2007
  • Medium-term inflation projections revised lower chiefly due to euro appreciation
  • Measures of underlying inflation have ticked up but remain at very subdued levels
  • Broad ‘dissatisfaction’ with inflation, but this is tempered by confidence that inflation will eventually converge with target
  • Most members reiterated worries about exchange rate pressures first raised by some policymakers at the last meeting
  • Appreciation of euro has ‘unquestionably’ led to tightening of financial conditions
  • ECB monitoring euro exchange rate, but doesn’t seem overly concerned about overshoot at present. (Could change if EURUSD hits 1.25?)
  • Interest rates will remain at present levels well past end of QE finishes; ECB still stands ready to increase the QE programme in terms of size and/or duration
  • No discussions on scarcity of bonds (seems unlikely), Draghi says ECB has repeatedly shown it can cope with scarcity issue
  • Draghi keen to stress that patience is needed, wont ‘experiment’ with interest rate forecasts
  • Draghi reiterated need for structural reforms to be substantially stepped up
  • ECB not resigned to permanently low inflation, expects convergence with target sooner or later
  • EURUSD rises above 1.20 handle to retest August’s 2 ½ year highs

 

Mission largely accomplished: Mario Draghi successfully guided the market to expect a tapering announcement in October without sounding hawkish.

No move on QE yet but the ECB will outline the next steps for monetary policy at its next meeting in October. At this meeting there were only very preliminary discussions about the length of the programme and the size of monthly purchases, which Mario Draghi said were mostly about ‘asking questions’ rather than answering them. But overall a sense that despite dissatisfaction about inflation, the ECB thinks it will be ready to announce some degree of tapering next month, which has been enough to lift the euro above $1.20 again to retest its highest levels since Dec 2014.

The monetary policy statement was as expected. Interest rates will remain at present levels for an extended period of time, and well after QE finishes. And as thought the ECB retained guidance that it stands ready to increase the QE programme in terms of size and/or duration.

On projections, Draghi has some justification to proceed more cautiously than certain German finance chiefs would like.

Inflation was revised down as expected given the rise in the euro this year. Draghi himself has previously said that each 10% permanent effective exchange rate appreciation lowers inflation by around 40 to 50 basis points. In June inflation expectations were based on an average exchange rate of USD 1.08 per euro in 2017 and of USD 1.09 per euro over 2018-19. At 1.19 today it has come as no surprise that the projections had to be revised lower; what’s positive is that they weren’t revised down by as much as we might have thought, which reflects bullishness on underlying inflationary pressures.

Inflation was revised down to 1.2% in 2018 (prev 1.3%) and 1.5% in 2019 (prev 1.6%). The 2017 inflation projections were unchanged at 1.5%. Draghi hinted a decline in headline inflation due to energy prices towards the year end. But he was a touch more upbeat on underlying pressures, saying inflation ex-fuel and food is showing signs of picking up but, critically, is yet to show ‘convincing’ signs of sustained upward trend.

With inflation this low, Draghi has to make it clear that tapering is not the same as tightening – so extra emphasis on the high barrier to raising rates is part of that dovish slant being put on the communication. We saw more of that today with Draghi at pains to stress that rates aren’t going anywhere and that a very substantial degree of stimulus is still required

Remember the market has already been pricing in a taper so the ECB has to guide it in a certain direction – i.e. hold back expectations rather than fuelling them in order to rein in euro bulls. But euro strength is also a fact that the ECB will have to live with – the appreciation of the exchange rate is as much down to fundamentals like strong growth and better corporate earnings as monetary policy speculation.  The Eurozone economy is doing better than it has done at time in the last 10 years so the ECB will have to accept that euro appreciation is going to happen whatever it does. The question is at what point it starts to test the will of the ECB to taper – if it appreciates to 1.25 will the Governing Council be forced to retreat? This would be a troubling reversal for Draghi and one he will want to avoid at any cost. He left this open by saying if the ECB is not ready by October it can postpone but he’s all but committed to announcing a taper next month.

 

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