Carsten Brzeski’s blog

ECB Preview/Dr. Draghi’s treatment against bipolar disorder

Even without any new decisions at this week’s meeting, the ECB will increase its actual stimulus as the corporate bond purchasing programme and TLTRO II will only begin in June. The biggest news should come from the ECB staff’s latest projections and particularly the inflation forecasts. On the back of higher oil prices, the ECB could announce the first increase of its staff’s inflation projections since the start of QE.

The economic outlook is improving, somewhat. Growth in the Eurozone in the first quarter was better than expected and the economy has finally returned to its pre-crisis level. Even though the second quarter should bring some technical slowdown as illustrated by some weakening of confidence indicators, the overall outlook for the Eurozone has slightly improved. Particularly the latest increase in oil prices, if it leads to the expected strengthening of demand from oil-exporting countries, could turn out to be positive. On the other hand, however, political developments like Brexit fears and a rather general emergence of populist parties could easily limit the potential for upside surprises. In sum, we expect the ECB to stick to its very cautious take on the Eurozone economy.

Inflation at a turning point? Headline inflation is still close to zero but the recent increase in oil prices has given rise to speculation about a turning point in Eurozone headline inflation. Indeed, even though the latest spur came very probably after the cut-off date of the staff projections, higher oil prices should lead to the first upward revision of ECB staff’s inflation forecasts since the start of QE in early 2015. Such a revision looks even more likely, given the strong growth performance in the first quarter and the renewed weakening of the euro exchange rate. However, on the back of high unemployment and hardly any wage increases, any inflation turning point will be limited to oil prices. In this regards, the ECB staff’s take on core inflation will be much more relevant for policy decisions than any increase in the headline inflation rate.

Just a reminder: there is still more stimulus to come. While any increase in inflation forecasts on the back of higher oil prices is nothing more than technical normality, it could give rise to speculation about the timing of any ECB tapering. What is more, as such higher inflation forecasts would come at a time at which Fed hike expectations are again flaring up and at which market participants are well aware of German opposition to ultra-loose monetary policy. Nevertheless, in our view any kind of tapering speculations are premature. The ECB has not even started its corporate bond purchasing programme, yet. Nor has it started the new round of TLTROs. Both will start in June.

Calling Dr. Draghi. The discussion on monetary policy and market expectations about upcoming ECB action has shown signs of what we characterise as bipolar disorder over recent years. We expect the discussion to continue switching between helicopter money on the back of any growth concerns to imminent ECB tightening on the back of somewhat better growth prospects and higher oil prices. It will be Mario Draghi’s task to treat this bipolar disorder with soothing words, carefully acknowledging the ongoing recovery but at the same time stressing continued high uncertainties and risks. In addition and to shield the Eurozone against any ‘unwarranted tightening of monetary conditions’, Draghi could also emphasise the long period of inflation undershooting and the ECB’s willingness to tolerate oil-driven overshootings of the inflation rate.