ECB: No change but messaging important
We don’t expect the European Central Bank (ECB) will do anything new following its meeting later this week, but the messaging will be watched for any clues as to the Bank’s future monetary policy intentions, especially in respect to its asset purchase program (APP).
The ECB’s current APP is scheduled to end in March 2017. The critical question is what happens after that. With some of the recent economic data looking better, at least by the standards of recent history, attention is now focussing on the inevitable end of the program.
The Bank doesn’t revise its forecasts until the December meeting. At that time they will issue forecasts for 2019 for the first time. ECB staff typically adds the new two-year-out calendar year forecast to the horizon in their March projections. This has clearly been brought forward in light of the scheduled end to the asset purchase program.
The staff forecasts will acknowledge some of the recently better news with growth looking more solid (albeit at only around 1.5% per annum), the nascent recovery in credit growth, but particularly on inflation. Headline inflation is rising though that is in large part due to the base effect of lower oil prices from last year dropping out of the annual calculation and being replaced with higher oil prices more recently.
However, core inflation remains stubbornly stuck at around 1%, well below the ECB’s inflation mandate of “below but close to 2%”. Critical in the 2019 forecast will be the extent to which the Bank feels the current pick-up in headline inflation becomes more broadly-based and sustainable.
There are other considerations beyond the economic fundamentals. A recent speech by ECB Executive Board Member Yves Mersch highlighted the risk of negative side-effects from the ECB’s “non-standard policy measures” on banks, life insurers and pension funds. While he said the Bank doesn’t see any developments that would give rise to major concern so far, “we need to keep in mind that the longer our non-standard policy measures remain in place, the more pronounced their side effects will become”.
Those risks suggest to us the ECB’s experiment with negative interest rates in particular is over - further interest rate reductions are highly unlikely. That means the outlook for monetary policy is all about the APP. That doesn’t come without its own challenges, including what assets to buy.
Despite the risks and challenges the outlook for core inflation, along with an absence of any other policy support to lift domestic demand, suggests an extension of the APP beyond March next year is a done deal. The question is when to taper. There are two options; taper the program from March or extend the program at the current level of €80 billion per month for a while longer and taper later.
Given the recent focus on the risks of aggressive monetary policy easing, and the proximity of the current scheduled end of the program, it is not unreasonable to expect some clarity from the Governing Council about their post-March intentions soon.
It’s unlikely we will hear anything definitive from the Bank on its tapering intentions until the December meeting at the earliest. That decision will be determined by the path of inflation over the next few months (along with the full raft of economic data) and the Bank’s updated and extended forecasts. The outcome of the Italian constitutional referendum on 4 December may also have a bearing (more on that later this week).
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