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Carsten Brzeski's blog

Eurozone: Taper tiptoeing in Tallinn

ECB drops easing bias on rates and signals first baby step towards tapering.

The ECB kept all interest rates unchanged at today’s meeting, held in Tallinn, Estonia. While no interest rate changes had been expected, the better economic outlook motivated the ECB to slightly tweak its communication and signal a very first baby step towards tapering.

It was a bit like in the good old days when ECB watchers looked out for code words like “vigilance”. This time around, all eyes were on the ECB’s forward guidance on interest rates and the risk assessment for the economic outlook. On both, the ECB delivered some changes. As regards the forward guidance on interest rates, it was not about what the ECB said but what it actually didn’t say. The ECB omitted the reference that interest rates could even be lower than their present levels and therefore dropped the easing bias for interest rates. Let’s not forget, however, that at the same time, the ECB kept the easing bias on QE, sticking to the formulation that the ECB would be willing to step up its monthly asset purchases if need be. Also, Draghi remarked that the ECB will remain in the market for a long while and the QE tapering was not discussed at today’s meeting. As regards the ECB’s macro-economic assessment, the ECB upgraded the risk to the growth outlook from negative to now “broadly balanced”. Actually the first time since 2011 that the ECB calls the outlook for growth balanced.

The improved economic outlook, however, has not yet led to any significant inflationary pressure in the Eurozone. This picture was reflected in the ECB staff’s economic projections which were marginally upgraded to 1.9% (during the Q&A session, Draghi said that due to the upward revision of 1Q GDP, growth would actually now come in at 2%), 1.8% and 1.7% in 2017, 2018 and 2019 respectively. At the same time, the inflation projections were revised downwards to 1.5%, 1.3% and 1.6% for 2017, 2018 and 2019. Even though the downward revision was mainly the result of lower oil prices and a slightly stronger exchange rate, subdued inflation rates remain the biggest concern for the ECB. Reasons for low inflation rates are in our view not only the slack in the Eurozone economy, still high unemployment and a high number of (involuntary) part-time and low-wage employment but also globalization and digitalization.

In our view, today’s ECB meeting was a very first baby step towards eventual tapering. It is obvious that the ECB is trying to be as cautious as possible to very gradually get out of the unconventional monetary policy measures. Therefore, this process of preparing markets extremely carefully with words and changes in the communication will continue and can take a long while before the ECB delivers new action. In this context, the low inflation forecasts in our view argue in favour of only a mild tapering and probably a tapering without an end date on it. There is clearly room for another “longer but lower” announcement for 2018 later this year.

All in all, the ECB today delivered two important linguistic changes to its official communication which were more than only words. These changes marked the official start of a taper tiptoeing. A tiptoeing which will still take a long while before it could be called policy normalization.