ECB Hardly Shaken, Barely Stirred

ecb

Investors seem more concerned about series of disappointing EMU data in recent months than the ECB.  There is little near-term uncertainty about the trajectory of policy.  Nor will the ECB be concerned about the euro, which although it is at the lower end of two-month range against the dollar, it is in the upper end of the range on a real trade-weighted basis.

The ECB meeting concludes tomorrow.  There is little doubt about what it is going to do:  nothing.  Uncertainty around its asset purchase plan and its economic assessment are also minor.

The current 30 bln euro a month of asset purchases will continue through September.  The market has come around to our view that the purchases will be tapered further in Q4 before concluding at the end of the year.

The economic data seen since the start of the year have generally been weaker than economists’ forecast.  There is no sign whatsoever that officials are concerned.  Less than a week ago, Draghi told the IMF, “Notwithstanding the latest economic indicators, which suggest that the growth cycle may have peaked, the growth momentum is expected to continue.”  The IMF itself raised this year’s EMU growth forecast to 2.4% from 2.2%.

Trend growth, or the non-inflationary pace, is estimated to be around 1.25%.  Growth that is faster theoretically absorbs economic slack and underpin price pressures.  That means that a modest growth disappointment will not distract the ECB.  Moreover, there are a few mitigating factors, like unusually poor weather, and a particularly virulent flu season, and some labor unrest.  We have also suggested that Q4 data may have been exaggerated too.  At the same time, the economic cycle is maturing.

Although the EMU does not have fiscal stimulus the US is enacting, which will likely extend the late-cycle expansion, unemployment levels are still elevated in many countries, and there is more slack that can and will be absorbed.  Moreover, despite rising market rates, the ECB Q1 survey found banks have eased their terms of credit, and will likely do so again in Q2, for house purchases and consumer credit.

Eurozone inflation is steady.  The headline rate softened in February and snapped back in March.  The preliminary April reading will be released next week.  The CPI stood at 1.4% year-over-year in March.  This is the same pace as December 2017 and a pinch lower than the 1.5% pace seen in March 2017.  The rise in oil prices will likely feed-through into higher headline inflation going forward.

The core rate was stuck at 0.9% in Q4 17.  It edged to 1.0% throughout Q1.  Last March it stood at 0.7%.  The weaker euro may boost the core rate.  Also, trying to strip away some of the noise in the high-frequency time series also suggests an underlying firmness.   Besides reviewing the economic and financial developments since the last meeting, Draghi is unlikely to signal a change in forecasts.  These are provided by the staff quarterly.  The next update is in June.

At the March meeting, the ECB dropped the commitment to buy more assets if needed.  This is simply housekeeping and did not really tell the market anything it did not already know.  The ECB is tapering.  The economy is growing above trend.  The ECB does not need to make the commitment explicit.  If there is a substantial negative shock, the ECB can, of course, respond.  It is not prudent to underestimate this with or without the explicit promise.  It should always be thought of as implicit.  Dropping the explicit reference is a way to gradually transition of the forward guidance to a new phase what the asset purchases cease. 

The ECB’s February meeting coincided with US Treasury Secretary Mnuchin’s comments that seemed to talk the dollar down, which apparently was a subject of discussion among the ECB.  The March meeting was marked by heightened trade tensions.  Both of these issues have subsided, though there is risk that the trade issues flare again soon as the deadline for exemptions for the steel and aluminum expire May 1.

It seems unreasonable to expect Draghi to shed much light on the interest rate outlook.  What investors can count on is that the first rate hike will happen sometime after the asset purchases are finished.  It is time dependent insofar as the ECB has outlined the sequence, but it is data dependent in terms of timing of the rate hike.  We had penciled it in for around the middle of 2019, before Draghi’s term ends that October.  Disappointing data in H1 19 could see that pushed back into Q3.  It is difficult to see the hike in Q1 19, but stronger data, especially price pressures, could see it move into Q2.

Don’t be surprised if Draghi says little if anything about the euro.  The euro is trading at the lower end of a four-month trading range against the dollar.  Macroeconomists have little problem in explaining it.  After all, the US is paying a historically wide premium over Germany to borrow and much more than the inflation differential.  As a central banker, Draghi will be more interested in the euro on a real trade-weighted basis, which is better than bilateral nominal exchange rate for assessing the economic impact.  On this metric, the euro is in the upper half of its four-month range.

It is not clear when the ECB will formally address the post-September strategy. New staff forecasts will be offered at the June 14 meeting, and this would seem to be a likely venue.  However, officials often seem reluctant to make a decision until they have to, and that suggests the July 26 meeting for a change in the forward guidance.