The ECB has its first meeting next week since the beginning of asset purchases under its public sector programme started. President Draghi’s big challenge in the press conference will be to sound positive about the impact of QE and the outlook for the economy without sounding like it is going ‘too well’. He is likely to make it clear that the central bank plans to continue asset purchases to at least September 2016 and we think he is likely to successfully dismiss talk of tapering or exit. This task will become much more challenging later in the year, and certainly in 2016, as the economy continues to gain momentum.
At the press conference, ECB President Draghi’s big challenge will be to strike a balance in his communication
Nick Kounis Head of Macro Research
ECB meets after positive start to QE
Next week the ECB’s Governing Council has its first monetary policy meeting since its Public Sector Purchase Programme (PSPP) began. The programme has led to a further easing of financial conditions, while it has also coincided with a period of consensus-beating economic data. So as at the March meeting, the ECB will be encouraged about recent developments.
Draghi will need to strike a balance
At the press conference, ECB President Draghi’s big challenge will be to strike a balance in his communication. On the one hand, he needs to sound positive about the impact of QE and the outlook for the economy. This will help to support confidence as well as inflation expectations. On the other hand, he needs to avoid the impression that things are going ‘too well’.
Investors already talking about QExit
This could encourage talk that the ECB will start to taper or even exit the QE programme (or QExit) earlier than currently expected. Indeed, discussion of this possibility is already big among fixed income investors. In addition, Executive Board member Yves Mersch, who said earlier this week that the ECB could adjust the pace of asset purchases if it looks like it is on track to meet its inflation goal more quickly.
Draghi likely to dismiss talk of taper or exit
However, unlike Mr Mersch, we think Mr Draghi will not speculate about the possibility of a tapering of asset purchases or early exit. He will more likely stick to the line that that the central bank plans to continue asset purchases to at least September 2016. This is because it is much too early to be confident that the ECB will meet its inflation goal over the long-term. Core inflation is still very low, and the economic recovery is only starting to look more convincing. It would be madness to risk it all by hinting at the possibility of less QE at this stage. Given the big impact the programme has had on financial markets, there could be an abrupt correction. The ECB could be back to square one in a flash!
Calming QExit talk could become more challenging later
So we think President Draghi will fight against any suggestion that the ECB will not stay the course and will successfully shape market expectations in this direction. However, this task will likely become more challenging later in the year and in 2016. We expect economic growth to beat expectations in coming quarters. In addition, inflation is likely to rebound later in the year as the impact of energy prices dissipates. We are likely to see further rises in 2016, as the impact of the lower euro feeds through into consumer prices.
The hawks could become louder
More hawkish ECB Governing Council voices may start to become louder at that point. In any case, even if the ECB stays the course to September 2016, investors will probably pre-position. Although we expect bond yields and the euro to fall further this year, they will likely rebound next.
Futures tweaks to modalities
Another key issue that Mr Draghi might be asked to address is about whether the ECB plans to change the eligible universe of the programme. Data published earlier in the week showed that the ECB managed to hit its EUR 60bn target for asset purchases in March, with national public sector buys broadly in line with the capital key. However, it will become more difficult going forward as the ECB will create a scarcity of core bonds in particular. In addition, the eligible universe for asset purchases could shrink further as bond yields become more negative. For instance, earlier in the week, 4-year German government bond yields fell briefly below the -20bp level that would excluded them from Bundesbank purchases. The ECB could decide to expand the national agencies that national central banks are allowed to buy at some point.
Fed policy also key for the ECB
Apart from developments in eurozone growth and inflation, the Fed’s monetary policy will be another key factor influencing the eventual scale of the ECB’s QE programme. This is because the Fed’s decisions will also influence EUR/USD. The later the Fed starts hiking, the higher EUR/USD will be all other things being equal and vice versa. So if the Fed delays hiking, the ECB will more likely need to do more QE to achieve the same degree of stimulus via a lower euro.
FOMC minutes point to rake hike in 2015
The minutes of the March FOMC meeting published earlier this week suggested that almost all members thought that a rate hike this year was appropriate. However, the Committee was split on whether it should be in June or later in the year. One point of agreement was that once the tightening cycle begins, it will be relatively gradual. Overall, we think that the Fed will raise its policy rate for the first time in September and will subsequently raise rates once every other meeting. This would represent a slow pace historically.
Positive sounds on Greece progress
In between the highly charged political rhetoric, the Greek Prime Minister’s visit to Russia, and Grexit talk, there were some rays of light this week on Greece. EU officials reported that progress between Greece and its partners was being made behind closed doors, and there was confidence that a deal would be reached before the end of the month. The Eurogroup – scheduled for 24 April – looks to the date that both parties are aiming for such an agreement. That should allow a disbursement of funds to Greece and eventually allow Greek banks to have normal access to the ECB’s regular refinancing operations.
Greece’s race against the clock
That would not be a day too soon! Although Greece managed to pay the IMF this week, cash is running out. The banks are also having a liquidity challenge given deposit withdrawals. The ECB raised the Emergency Liquidity Assistance (ELA) ceiling for Greek banks by EUR 1.2bn this week, taking it to more than EUR 73bn.
Signs that global growth will firm again
Although the eurozone economy has been beating expectations, the global economy looks to have slowed significantly at the turn of the year. Our view on this has been that special factors have been at play. For instance, particularly bad weather in some regions in the US, and the port strikes on the west coast. There was some evidence this week that the US economy is lifting. For instance, the Markit PMIs for both manufacturing and services rose in the US in March. We also saw a significant – and continued – upswing in the global all industry PMI. Furthermore, the 4-week average of US initial jobless claims fell to the lowest level since June 2000 last week. This suggests that the soft nonfarm payrolls reading last week was an aberration rather than the start of a new trend.
Eurozone looking good
As mentioned before, the eurozone economy is one of the few economies that looks to have done well in Q1. Consumer spending seems to have been a particular bright spot. Retail sales slipped by 0.2% in February, but that followed a 0.9% gain in January and a 0.6% rise in December. The series tends to be volatile and the limited payback in February points to a strong underlying trend. The fall in oil prices, improving household expectations about labour market prospects and easing financial conditions are leading to stronger consumer demand. Admittedly German factory orders were weaker than expected in February. However, given the fall in the euro and stronger global demand we expect the industrial sector to also do well in the coming months.