Carsten Brzeski's blog

ECB Preview/Keeping the hawks in check

With headline inflation in the Eurozone back at the magic 2%, the ECB hawks and critics will gradually sense that their moment has come to push for tapering. In our view, however, they will not want to add any new uncertainty on the eve of two important elections in the Eurozone. Therefore, we expect no action at this week’s ECB meeting and some dovish rhetoric instead.

Solid momentum continues. The economic situation in the Eurozone has improved further since the end of last year. Despite political risks, Eurozone sentiment indicators have continued to increase, with some indicators currently at the highest levels since early 2011. Still, we need to bear in mind that up to now, the only hard data for 2017 disappointed, as retail sales dropped for the third month in a row. This week’s batch of German industrial data should give a better grasp of to what extent the soft indicators really are reliable. At the same time, inflation has also accelerated and reached the magic 2% line for the first time since early 2013.

New staff projections. Given that most of the current positive momentum stems from soft indicators, the ECB’s latest staff projections should hardly show any changes compared with the December forecasts. In our view, the main changes will come from the external assumptions. Higher oil prices and a weaker euro exchange rate could lead to a small upward revision of the inflation forecasts for this year and next and would definitely not make the ECB’s life any easier.

Watch the core. With possibly only small changes to the inflation and growth projections, the expected path for core inflation should be more interesting. Recall that in December, the ECB expected core inflation to come in at 1.1% in 2017, 1.4% in 2018 and 1.7% in 2019. In the first two months of the year, core inflation was on track, with an average of 0.9%. Any changes to the outlook for core inflation will, in our view, have more relevance for the path of monetary policy than twists in headline inflation.

Time to taper? Against the backdrop of recent inflation developments, some market observers have again brought up the need for countermeasures to fight increasing inflation and to commence early tapering. Interestingly, no ECB member has recently shared this view in public. Even the often outspoken German members of the ECB’s Governing Council sounded somewhat more cooperative and uncontentious.

Institutional memory. An important reason for not taking any hasty action is the ECB’s own track record of jumping the gun. In 2007/8 and 2011, the ECB hiked rates, the first based on German wage increases and the second when the worst of the Eurozone debt crisis seemed to be over. Both times, the ECB was taught a lesson. It seems unlikely that the ECB would want to jump the gun for a third time, particularly not on the eve of two important elections in the Eurozone.

What to expect? We expect ECB President Draghi to repeat his four criteria defining a successful fight against low inflation: (i) a durable convergence of inflation to below but close to 2%; (ii) a non-transitory increase in inflation; (iii) inflation should be self-sustained; and (iv) the inflation improvement has to be across the entire Eurozone. None of the four criteria have been met so far. Therefore, any changes to the current monetary policy stance seem highly unlikely this week. At best, we could see some tweaks to the ECB’s take on the economy. For the most part, Draghi will, once again, try to keep the hawks in check.

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