Carsten Brzeski's blog

Eurozone: (No) final guidance

At his regular hearing at the European Parliament, ECB president Draghi kept his cards to his chest. If anything, he sent a clear dovish reminder to those who are expecting big action next week.

Not only due to the fact that financial markets in many regions were closed yesterday, ECB president Draghi’s regular appearance at European Parliament was probably the highlight of the day. It was the last chance for Draghi to shed some light on the ECB’s thinking, just more than a week ahead of the next regular rate-setting meeting, next week Thursday.

To keep it short, Draghi kept most of his cards to his chest and did not pre-empt the discussion within the ECB’s Governing Council. There were no hints at tapering or any other possible upcoming action. To the contrary, Draghi even sounded more dovish than some market participants probably had expected. In this regards, two statements were remarkable: the most significant one was the statement that “an extraordinary amount of monetary policy support, including through our forward guidance, is still necessary”. The other, more subtle dovish remark, was the fact that Draghi left out the reference to gradually increasing underlying inflationary pressures. On the more hawkish side, Draghi acknowledged the further improvement of the cyclical recovery of the Eurozone economy.

Even though the recent set of positive sentiment indicators has stirred a new debate in financial markets about imminent ECB tapering or even ECB rate hikes, Draghi’s comment sent a clear signal that the ECB was not up to any change any time soon. In our view, the ECB will continue making a clear difference between growth and the cyclical recovery on the one hand and the absence of inflationary pressures on the other hand. In fact, weak core inflation, still high (and also hidden) unemployment and structural problems are strong arguments against any significant pick up in core inflation. This should also be reflected in the ECB’s staff projections, which will also be published next week. In this regards, the stronger euro exchange rate and lower oil prices could actually lead to a downward revision of the ECB’s inflation projections for 2017 and 2018. More evidence that the ECB will be in no hurry to taper.

Against the background of the above, next week’s ECB meeting will in our view only deliver new words but no action. The ECB seems to have a high interest in a very gradual and cautious preparation of financial markets. In this regards, in our view, the ECB will continue looking through high frequency data and focus on the broader trend. For the June meeting, we expect the ECB to announce first subtle changes to its risk assessment and forward guidance. This could be followed by tasking the working committees to study several options for tapering, maybe even including the sequencing, at the July meeting. The official tapering communication could then follow between September and December. Time for market participants to rethink their own ECB assessment. Some market players have clearly got carried away by their own wishful thinking. The ECB does not seem to be in any rush to drastically change its current stance.