ECB: Potential to disappoint

Thursday’s meeting of the European Central Bank (ECB) comes at a time of buoyancy in the Eurozone economy that we’ve not seen for years. Growth is picking up, headline inflation is on target and corporate earnings are soaring.

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The ECB is certain to leave rate and QE unchanged, so the focus is on the forward guidance – where the bank expects policy to be in the future.

But those hoping for a more hawkish tone from the ECB could be left disappointed. Weakness in core inflation (at just 0.9%), continued high unemployment and a raft of political risks mean Mario Draghi is unlikely to steer markets away from the current play. He is likely to be more upbeat on growth and corporate earnings but this is not expected to translate into any material shift in policy outlook.

Rate expectations

 

Markets are pricing in a first interest rate rise in 2018 but this could be premature. 

The ECB remains dovish but watch for a shift in tone. In January it stuck to the line that policymakers “expect interest rates to remain at present or lower levels for an extended period of time, and well past the horizon of our net asset purchases”.

If this goes from the communique then the euro could rally firmly on hopes that the ECB is ready to tighten sooner rather than later. This is where the bulls will be pinning their hopes for the euro to rally.

Draghi doesn't want a repeat of 2011 or 2008, when the ECB tightened too quickly. This fear is likely to drive policymakers to remain dovish and keep the taps open. The risks remain to the downside - even with what markets consider 'too much' QE.

The 'high class problem' talked about by Draghi is that the European economy is doing better and the talk is now of tightening. The longer the ECB is minded to refrain from changing policy, the more markets will expect a rate rise or tapering to come. Indeed markets are doing a lot of the tightening work for the ECB as the front end of the yield curve is rising. 

Inflation

 

Inflation climbed to 2% but the underlying rate of inflation – which strips out fuel and food – is just 0.9%. Expect Draghi to emphasise the volatile nature of prices and play down the headline rate.

While the ECB is expected to increase its 2017 inflation forecasts, the core inflation measures for 2018 and 2019 are not forecast to change. Therefore it seems unlikely that the ECB will strike its dovish language on rates just yet.

Corporate earnings

 

Corporate earnings should be a source of comfort for Draghi and co but hardly enough to make the ECB change course now. European earnings rose 11% in the fourth quarter (Stoxx Europe 600), beating the 5% for the S&P 500.