Will the hype around the ECB ever amount to tighter policy?


 In last Monday’s report, we debated whether the recent bull run in the euro can continue. At the ECB meeting on Thursday, Draghi justified our belief that it may struggle with the committee set to maintain a very cautious approach to tightening policy.

 

Most commentators reported Draghi’s stance as being slightly less hawkish than expected. He announced that the market will need to wait until at least October for more details on the tapering of the QE program (which currently stands at EUR 60 billion per month). The consensus (which hasn’t really changed) is for asset purchases to be scaled back gradually throughout 2018 – most likely halved in H1 and reduced to zero by the end of H2.

 

The more dovish aspect of Draghi’s communique was his strong emphasis on the point that whatever the ECB decides on QE in October / December, the policy rate will remain low “well past” any QE end date. As such, the futures market has scaled back expectations of a rate hike from December 2018 to March 2019. Even then, we believe this may be a little too hawkish.

 

If Draghi and his council are to remain focused on inflation (as per the ECB’s mandate and in line with message delivered in recent years) the recent dip in CPI (see chart below) implies that there is no need for higher rates anytime soon. In fact, the ECB’s own projections for core inflation were revised down by 0.2% to 1.5% for 2019 although Draghi still expects inflation to reach the 2% target in 2020 (we will have to wait until December for the official ECB forecasts).

 

Critics may argue that the recent rally in oil prices (+8.4% since the start of 2017) is yet to fully impact the CPI reading, but this will be more than offset by the recent rally in the euro (+10.3% over the same time frame). Furthermore, with Eurozone unemployment still running above 9%, there seems little prospect of higher wages feeding through to higher price pressures in the medium term.

 

CHART 1: Eurozone CPI

 

Picture1

 

Given the downside risks to inflation, we once again see longer term risks to the euro. While a reduction in concerns about the prospect of a Eurozone break-up were the key influence triggering a mass unwind of short EUR positions, the prospect of higher rates will almost certainly have been the driving force behind the build-up of near record long positions (see chart below). Therefore, if it becomes clear that the expectation of higher rates will fail to transpire and sentiment changes, expect this positioning to reverse (potentially very quickly).

 

CHART 2: EUR Positioning

 

Picture2

 

Author: Marc Cogliatti



 

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