ECB Preview: What Does Draghi Really Think About Italy

Submitted by RanSquawk

The ECB Monetary Policy decision is due at 13:45 CET, 07:45 EDT, On Thursday 25th October 2018, with the press conference 45 minutes later. Unanimous expectations look for the ECB to leave its three key rates unchanged while markets await any updates on the bank’s assessment of Europe’s economy and the bank’s reinvestment policy after Draghi stated the issue will be discussed before the end of 2018. Draghi likely to be grilled on the Bank’s concerns over Italy’s budgetary demands.

BACKGROUND

PREVIOUS MEETING: As was the case with the July meeting, September’s policy announcement delivered little in the way of fireworks with the governing council’s statement broadly unchanged from the prior release. The press conference saw Draghi note that incoming data confirmed the Bank’s previous assessment that growth is broad-based, inflation is rising and the strength of the economy supports confidence. In terms of the latest economic projections, 2018 and 2019 growth forecasts were lowered to 2.0% and 1.8% respectively with all other projections maintained. Furthermore, Draghi gave very little away with regards to the Bank’s intentions for further policy normalisation by stating that the ECB’s first rate hike was not discussed. Draghi also stated that reinvestments were not discussed but would be at one of the meetings before the end of 2018.

ECB MINUTES: ECB minutes drew little in the way of a market reaction with the release more of an account on the governing council’s view on the Eurozone economy rather than any insight into what policy discussions took place. The release highlighted the view that factors behind the growth slowdown may not be transitory, trade tensions could lead to a more general decline in confidence and that the adverse effects of trade tensions have been so far limited but might still impact the euro area over time.

SOURCE REPORTS: In the immediate aftermath of the meeting, sources revealed that a few ECB policymakers wanted the September policy message to say risks were tilted to the downside. Elsewhere, sources on October 11th reported that the Bank would not come to the rescue of Italy if the government and banks run out of cash unless an EU bailout is in place.

ECB RHETORIC: One of the most notable interjections seen since the previous meeting came from ECB President Draghi who stated that he sees a vigorous pick-up in underlying inflation. This was met with a hawkish reaction by the market. However, the comments appeared to be the policymaker justifying the economic projections released at the September meeting and thus wasn’t necessarily new information; a view point that was backed up by Praet the following day. Knot recently stated that the ECB are comfortable with the wording of forward guidance adding that a hike may come sooner or later than guided. Knot even went on to state that one potential option for the Bank would be publishing how many times they intend to raise rates in a given year. Elsewhere, Chief Economist Praet recently suggested that the market had moved a little too dovish.

DATA: On the growth front, HSBC highlight that the most recent growth forecasts from the Bank could be in jeopardy with analysts suggesting that the ECB’s references to soft manufacturing activity in the September minutes could make a Q3 0.5% GDP print unlikely. From an inflation perspective, Eurozone CPI in September remained at 2.1% Y/Y, however, the super-core metric remains subdued at 0.9% Y/Y and thus is showing little sign of gaining momentum. The latest survey data from the Eurozone was relatively unencouraging with the composite EZ metric slipping to 52.7 from 54.1 with Markit noting the multi-bloc economy grew at its slowest level in over two years whilst expectations of future growth slipped to the lowest for nearly four years

CURRENT ECB FORWARD GUIDANCE (INTRODUCTORY STATEMENT)

RATES: We continue to expect them to remain at their present levels at least through the summer of 2019, and in any case for as long as necessary to ensure the continued sustained convergence of inflation to levels that are below, but close to, 2% over the medium term. (Sep 13th)

ASSET PURCHASES: After September 2018, we will reduce the monthly pace of the net asset purchases to €15 billion until the end of December 2018 and we anticipate that, subject to incoming data confirming our medium-term inflation outlook, we will then end net purchases. We intend to reinvest the principal payments from maturing securities purchased under the APP for an extended period of time after the end of our net asset purchases, and in any case for as long as necessary to maintain favourable liquidity conditions and an ample degree of monetary accommodation. (Sep 13th)

GROWTH/TRADE: The risks surrounding the euro area growth outlook can still be assessed as broadly balanced. At the same time, risks relating to rising protectionism, vulnerabilities in emerging markets and financial market volatility have gained more prominence recently. (Sep 13th)

INFLATION: The underlying strength of the economy continues to support our confidence that the sustained convergence of inflation to our aim will proceed and will be maintained even after a gradual winding-down of our net asset purchases. (Sep 13th)

POTENTIAL ADJUSTMENTS TO ECB FORWARD GUIDANCE (INTRODUCTORY STATEMENT)

RATES: No adjustments expected on this front. Even ECB-hawk Knot has suggested that such adjustments on rate guidance wouldn’t be discussed until early next year. That said, HSBC suggest that some at the ECB “might be starting to worry that, having tied its hands too tightly with its forward guidance, it might miss the chance to raise rates”. As such, HSBC believe that if the ECB remain confident in their ability to fulfil their inflation objectives, Draghi at some stage will need to “hammer home the message that markets should expect a rate hike, sooner rather than later”.

ASSET PURCHASES: The central bank will likely signal that purchases will continue to run at EUR 15bln a month until December with GS suggesting that the bar to an extension is simply too high. Instead of an extension to policy, market focus continues to remain on the Bank’s plans for its reinvestment policy (please see below for more detail analysis on this matter).

GROWTH/TRADE: In terms of adjustments, this aspect of the statement could be of greater focus for the market given the September minutes state concerns that “factors behind the growth slowdown may not be transitory, trade tensions could lead to a more general decline in confidence”. As such, some in the market have speculated whether or not this could force the Bank to review their ‘broadly balanced’ assessment. However, GS suggest that since these remarks ‘various Governing Council members have suggested that the broad view is still that the risk assessment of the economic outlook is balanced’; subsequently GS look for little in the way of material changes to the introductory statement.

INFLATION: Despite the market focus on Draghi’s comments in September whereby he spoke of a “relatively vigorous pick-up in underlying inflation”, UBS suggest the ‘remarks do not signal a change in the ECB’s assessment, but are more of a description of what the ECB has expected for some time”. Furthermore, UBS “think that recent speeches by Mr Draghi and other key ECB policymakers constitute explanations as to why the ECB introduced its monetary policy normalisation in June 2018 – rather than first indications that the ECB is about to further accelerate the pace of normalisation”. Therefore, it is unlikely that the ECB will materially alter their guidance on inflation at this stage.

PRESS CONFERENCE: WHAT TO WATCH OUT FOR

In terms of the contents of the press conference, a bulk of the ECB’s assessment on the Eurozone economy will be incorporated into the introductory statement with no staff economic projections this time around. Draghi will likely be quizzed on his assessment of the Eurozone economy in the Q&A but the tone presented by Draghi will likely be in-fitting with the introductory statement with the central banker likely to be mindful of not wanting to rock the boat as the ECB’s PSPP draws to a close. Interestingly, Rabobank questions whether Draghi’s optimism at the previous conference was driven by the economic outlook or the desire to curtail asset purchases. As part of the discussion regarding the Eurozone’s economic outlook, Draghi will likely be presented with specific questions on the Bank’s view on ongoing trade tensions, particularly given source reports ahead of the previous meeting which flagged concerns from the fallout of trade disputes. Since then, there has still been no material improvement on this front with the US recently accusing the EU of ‘dragging its heels’ in talks. That said, it is unlikely that the Governing Council will have enough information at this stage to provide a more coherent update and will most likely wish to see how talks between the EU and US play out.

Another line of questioning from journalists will likely centre around the Bank’s approach to its reinvestmnet policy. At the previous meeting, Draghi stated that reinvestments had not been discussed but would be a topic for discussion at one of the meetings before the end of 2018. As such, this leaves the ECB with either this week’s meeting as an opportunity to update markets or the final 2018 meeting in December before the PSPP concludes. For context, various reports over the past few weeks have hinted at a potential Fed-type ‘operation twist’ which would involve reinvestments being focused on longer maturities with the objective of maintaining control over the long-end of the curve. However, HSBC are “of the view that any formal announcement in that direction is unlikely: the ECB has been vague on the maturity of purchases and reinvestments, which allows it to be flexible in what to buy”. Furthermore, HSBC also highlight the issue of Bond scarcity for the Bank which could pose issues in buying bonds at the long-end, particularly Bunds. Barclays back this view by stating that any updates will likely be from more of a technical standpoint rather than anything that would imply changes to the ECB’s monetary policy course. In terms of actual timing for the announcement, as mentioned above, the next update from the Bank will come either this week or in December; GS and Rabobank suggest that the latter is more likely.

Given the current political climate in Italy, journalists will likely probe Draghi over events in his home nation and what the ECB could do to prevent economic spill-overs from a deterioration in the Italian economic outlook. To recap recent events, Italy has put itself on a collision course with the European Commission with regards to its budgetary plans which has prompted the Commission to write to Italy, highlighting their concerns. At the time of writing, it appears to be unclear how much (if any) ground Italy will concede with various media reports painting a mixed picture of the situation. The main concern for the Bank is that whatever compromises are struck between Italy and the EC, Italy appear to be adopting a particularly laissez faire approach to their structural deficit. In September, the ECB stated “full adherence with the Stability and Growth Pact is critical for safeguarding sound fiscal position”. As such, markets will be looking to state whether the ECB ups the intensity of their message to Italy with HSBC highlighting that the Bank could “play a crucial role in the future negotiations between Italy and the EU, with QE reinvestments being key to support the Italian sovereign bond market”. GS state that they believe “Draghi may provide some broad comments highlighting the importance of fiscal prudence” but “do not expect him to signal that any special measures targeting Italy are forthcoming”

 

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