The latest turmoil in the financial markets, fears that low oil prices could dent, instead of boost, global activity and continued concern about China and emerging markets have fed speculation about new ECB action. However, as the Eurozone currently seems to be in the calm eye of the current storm, and Draghi already had problems uniting the ECB for the December decision, we believe the ECB will keep dry the little powder it has left– at least for this week.
Eurozone in the eye of the storm? While the world around the Eurozone has worsened since the December ECB meeting, the Eurozone itself has remained surprisingly resistant. Judging from available macro data, there is no reason for the ECB to re-assess its monetary stance again this week. If anything, the Eurozone economy has further stabilised and the ECB’s base case scenario of a subdued recovery is still unfolding. Since the December meeting, confidence indicators have improved, inflation has remained unchanged (not really a surprise given the continuing drop in oil prices) and even loans to the corporate sector have rebounded somewhat. Only the drop in industrial production in November, driven by disappointing data from Germany, indicates that not all is perfect.
Risks have increased. Still, the risks for the Eurozone have not disappeared. To the contrary, the latest market turmoil, continued concerns about the Chinese economy, adverse effects from low oil prices and recent worries that the Fed might have jumped the gun in December have clearly increased the external risks for the Eurozone. And there is more. The negotiations with Greece on the implementation of the pension reforms, the new government of Catalonia and its separatist ideas, combined with the accelerating Brexit discussion and some turnaround in public support for Angela Merkel’s stance on the refugees in Germany stress that politics have become a risk for the recovery from the inside.
New ECB action unlikely at this point in time. While the latest market turmoil has intensified the discussion in financial markets about possible new ECB action, the minutes of the December meeting, in our view, show that such speculations are currently a bit far-fetched. Judging from the minutes, it seems that there is growing discord on the outlook for growth and inflation. While a majority of ECB members still pointed to the downside risks to growth and inflation, “some remarks” were made pointing to the improvement of underlying inflation and the cyclical recovery. Interestingly, the minutes suggested that some ECB hawks would agree to a cut in rates rather than more QE. Finally, as the December decision was already a compromise between the hawks and the doves, any additional measures based just on suspicion look very unlikely.
If not this week, what about later? In our view, the ECB will keep dry the little powder it still has left this week. Nevertheless, markets still see Mario Draghi as their monetary James Bond and believe in a strong “never say never again”. However, given that Draghi seems to have come out of the December meeting with at least some virtual bruises, he would need a strong unwarranted tightening of financial and monetary conditions in the Eurozone, a faltering of the recovery or a sharp drop in core inflation rates to get the full backing of the entire Governing Council for further action. None of the three is currently the case. This means that at least for this week, it will be sufficient for Draghi to sound dovish and to stress the ECB’s readiness to act and to use all instruments available.