Expectations for a commitment on tapering have fallen somewhat since the last meeting of the ECB. At its policy meeting on Thursday, the central bank is not expected to outline its plans for reducing monthly asset purchases, instead leaving this open for the October meeting, or even until December.
At the last meeting, Draghi hinted at an announcement on tapering by the autumn. While this got some hopeful for a move in September, recent euro appreciation and the lack of any improvement in inflation means he is unlikely to be hawkish. Another reason for the ECB to hold off for now is the upcoming German elections although this is of marginal importance. Meanwhile we must acknowledge that the pressure on the ECB is to avoid a mistake, therefore making it more likely it will take things as slowly as possible.
The rise in the euro may well dent inflation projections for 2018 and 2019 and this will be the chief reason for maintaining QE at current levels for as long as it can. Minutes from the last ECB meeting and other reports show growing concern about the euro exchange rate. While Mr Draghi will reiterate that this is not a policy target, he has a range of options to guide it gently lower. Given that he will face direct questioning from journalists on the topic, if he says the ECB is not bothered by the euro’s rise this could be a hawkish signal that pushes the currency past $1.20. Alternatively, he could signal that the exchange rate has received attention, that the ECB is worried about an overshoot.
On QE, the ECB might be minded to remove from its statement that it stands ready to increase or extend QE is required. Given that market expectations are firmly of the believe that the ECB is preparing to taper, this would seem an unnecessary hawkish signal. There is little to be gained from changing this easing bias.
Recent inflation prints have been solid lower projections for price growth will mean the ECB looks past these. Eurozone inflation rose faster than expected to 1.5% in August from 1.3% in July, while the more closely watched core inflation number was steady at 1.2%.
Growth remains strong and is showing signs of accelerating further. This ought to temper any dovishness from the lacklustre inflation data and keep the ECB broadly on the same course as it has been.
The ECB may also wish to keep its hands free for any shift in the US, waiting to see whether the Federal Reserve follows through on promises to scale back its balance sheet. If the Fed starts to get cold feet this could have implications for the ECB as it will seek to avoid further euro appreciation.
If the ECB does outline plans for tapering this is likely to be in the form of a dovish surprise. It could signal it will taper from the beginning of 2018 but only by a small amount and for an extended duration; effectively a dovish taper that could drive back the euro.
Indeed, so far the market appears to have been front-running ECB tightening; in other words reading too much into policy signals too early. Premature tightening in the market is not what the ECB wants and so this makes it all the more important for the exit strategy to be dovish – very accommodative whilst still dialling back slowly.
It comes down to a simple trade-off. Euro strength means the ECB believes it can only afford baby steps. That said, this time is a little different to the last two occasions when the ECB tightened prematurely – euro strength is being driven by strong growth and demand for eurozone assets as outflows switch to inflows. The ECB may afford to be more ambition, but it is likely to remain hyper cautious.
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