If anything, the Italian referendum should have provided ECB President Mario Draghi the final argument to convince the ECB hawks to deliver the bare minimum at Thursday’s meeting and extend QE beyond March 2017. While some ECB members seem to favour first hints at tapering, we think that the majority will prefer to avoid giving any signals that could be misunderstood by markets.
Solid but not solid enough. The macro-economic data released since the last ECB meeting has been rather positive. Up to now, the negative impact from unexpected political events elsewhere, like Brexit and Trump’s victory, has hardly left any marks on the Eurozone economy. However, given the slow improvement in the labour market, the current growth path still seems to be too weak to give the all-clear.
Difficult times for forecasters. With mixed soft indicators appearing solid, but the underlying gut feeling being queasy, given an extended series of political risks and uncertainty, conducting quarterly staff forecasts could not have been an easy exercise. Just looking at the so-called external assumptions and their respective changes since the September projections show that slightly higher oil prices and a somewhat weaker trade-weighted euro exchange rate should marginally lift the ECB’s inflation and growth projections for next year. More generally speaking, however, the underlying story of a gradual recovery should not change. For monetary policy purposes, it will be interesting to see whether the ECB will provide any hints at its 2019 projection for headline inflation. Normally, the official projections should not cover 2019 as yet.
Emphasis on uncertainty. At first glance, the staff projections could make it harder for the ‘monetary doves’ to argue for an extension of or even more QE. However, at second glance, there are plenty of arguments for the doves to get what they want. Last week, Draghi presented the main argument in an interview with the Spanish newspaper El País, by stating now that oil prices had increased, monetary policy remained the major (and only) driver of the Eurozone recovery. Previously, Draghi had stated that there were still no signs of increased underlying inflationary pressure. Finally, as on an earlier occasion, we expect Draghi to stress the high uncertainty in markets and, by extension, surrounding the staff projections. In this regard, the ECB might not be extremely unhappy with the ‘No’ vote in the Italian referendum, as it could provide more persuasive power to the ‘uncertainty’ argument. It will not be the first ever time that the Governing Council’s economic assessment diverts from staff projections.
Now is not the time…to taper. Evidently, some Governing Council members prefer to end QE earlier than later. However, at the current juncture, with increased market nervousness and political uncertainty, any hint at future tapering could easily be misunderstood and lead to an unwarranted tightening of financial conditions. Therefore, we think that the ECB will be very cautious and want to avoid any possibility of tapering for the time being.
Extend and pretend. In our view, uncertainty and the ECB’s conviction that QE has been the big ‘game changer’ for the Eurozone will lead to an extension of QE by three-to-six months. The ECB could, probably, even postpone addressing the scarcity issue. If it does not, an increase of the threshold for purchases of non-CAC bonds per issuance from 33% to 49% is, in our view, the most likely option.