- Unanimous expectations look for the ECB to leave its three key rates unchanged
- Focus will fall on what hints/if any Draghi delivers on the future path of the Bank’s PSPP
- Markets will also be looking out for any potential comments from the ECB President on the ongoing EUR appreciation
During the last two weeks markets have reacted to every single comment from ECB speakers. As Bank of America writes, far from the “peace and quiet” the ECB probably thought it had bought itself last October, this clearly suggests the press conference this week will not be an easy one for Draghi. This reflects what some have highlighted before: changing one part of forward guidance opens the door to the market questioning every single bit of it.
Communication risks will abound. Getting the right dosage in the successive changes in language will be tricky, especially if divisions appear within the Governing Council. Higher volatility is likely to be a side-effect as we have seen in recent days. Hence, expect Draghi to emphasize two main messages.
- First, that any changes to communication, the most relevant ones, will only be very gradual. The minutes were clearly laying the ground for a gradual change in communication.
- Second, that the sequencing is an ironclad element of forward guidance. Reaffirmation of “sequencing” will be a recurring and crucial element of communication. And do not forget that today’s sequencing also states that rates would not rise before “well after” the end of the net purchases, not just “after”. At this stage, given the prevailing bearishness on inflation, the ECB will maintain this to stop the market from pricing the first hikes too quickly into late 2018/early 2019 and the currency from strengthening further.
- BofA’s sees risks of a more hawkish outcome, but that does not affect the timing of the first rate hike but the speed of the hiking cycle once it starts. The need to avoid further tightening both through real rates and the currency, limits the extent to which hikes can be brought earlier in time. A smooth transition to a new normal with no net QE purchases and forward guidance transitioning from QE to rates requires credible communication. Reversing the sequencing would damage that credibility. Those expecting rate hikes at the end of this year may end up being disappointed.
Do not expect any major change to forward guidance this week apart from the removal of the asymmetry in QE, which is not consequential.
Will Draghi Talk The EUR Lower?
In the run up to this weeks’ rate decision, a number of ECB officials have been vocal in their attempts to curb the recent rise in the EUR. These comments have coincided with the rally toward 1.23 in EUR/USD which appears to be a de facto line in the sand for many officials. The EUR/USD has benefitted from cyclical support as markets increasingly focus on ECB QE-exit and a shift in ECB forward guidance toward more conventional (rates focussed) guidance. While the December ECB Minutes have effectively consigned the QE era to history the cyclical outperformance of the EUR may have run its course and the single currency is vulnerable to comments from President Draghi during the Q&A session who may take the opportunity to address the recent appreciation.
While much of the attention has been on the EUR/USD rate, it is worth emphasizing that the EUR TWI is less than 0.5% higher since the start of the year. In this context, the appreciation of EUR is less impressive than the 2% rally in EUR/USD against the backdrop of broad-based USD declines. This may be relevant for Draghi given the appreciation in EUR/USD was accompanied by a 9% appreciation of the EUR TWI January 2017 – September 2017, which prompted his comments that EUR performance required monitoring. Given the slew of comments from ECB officials last week, markets are probably expecting FX to be addressed by Draghi. The risks are that he sounds more sanguine. It also makes the up/downside of bearish EUR bets ahead of the ECB announcement especially attractive.
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PREVIOUS MEETING: At the previous meeting, the ECB reiterated their existing guidance on asset purchases, upgraded 2017 through 2019 growth forecasts (2018 upgraded to 2.3% from 1.8%) with Draghi during his press conference stating that the ECB did not discuss a sudden end or an end date for asset purchases.
ECB DECEMBER MINUTES: The key takeaway was the Bank announcing that forward guidance and the language surrounding their policy stance could be revisited in the early stages of this year. Furthermore, the minutes revealed that communication would need to change but without changing sequencing.
SOURCE REPORTS: In the immediate aftermath of the December meeting, sources suggested that a minority of ECB Rate Setters wanted to signal guidance may change if inflation keeps accelerating but hawks were easily out-numbered and the debate was not heated. More recent source reports have suggested that the ECB are unlikely to drop the pledge this week to keep buying bonds until inflation heads towards target, with separate reports stating that the Governing Council are relatively relaxed about EUR appreciation; policy wording most likely changed in March.
DATA: From a data perspective, RBC highlight that the growth picture has remained strong with Q3 GDP recently revised higher to 0.7% (Exp. 0.6%), with the real test for the ECB to come throughout the year given their mammoth 2018 growth upgrade from 1.8% to 2.3%. Further to growth prospects, December PMIs revealed growth in the manufacturing sector at an all-time high with services at the highest since 2011 with HSBC suggesting that EUR appreciation is yet to dent Eurozone exporters. On the inflation front, things are perhaps less upbeat with December core CPI stuck at 0.9% for the third consecutive month and the potential for EUR appreciation to cap upside in inflation in the coming months.
CURRENT ECB FORWARD GUIDANCE (INTRODUCTORY STATEMENT)
- RATES: We continue to expect them to remain at their present levels for an extended period of time, and well past the horizon of our net asset purchases. (Dec 14th)
- ASSET PURCHASES: From January 2018 we intend to continue to make net asset purchases under the asset purchase programme (APP), at a monthly pace of EUR 30bln, until the end of September 2018, or beyond, if necessary, and in any case until the Governing Council sees a sustained adjustment in the path of inflation consistent with its inflation aim. If the outlook becomes less favourable, or if financial conditions become inconsistent with further progress towards a sustained adjustment in the path of inflation, we stand ready to increase the APP in terms of size and/or duration. (Dec 14th)
- GROWTH: Risks surrounding the euro area growth outlook remain broadly balanced. (Dec 14th)
- INFLATION: The strong cyclical momentum and the significant reduction of economic slack give grounds for greater confidence that inflation will converge towards our inflation aim. At the same time, domestic price pressures remain muted overall and have yet to show convincing signs of a sustained upward trend. An ample degree of monetary stimulus therefore remains necessary for underlying inflation pressures to continue to build up and support headline inflation developments over the medium term. (Dec 14th)
POTENTIAL ADJUSTMENTS TO ECB FORWARD GUIDANCE (INTRODUCTORY STATEMENT)
- RATES: Guidance on rates is likely to be maintained with RBC highlighting that the most recent ECB minutes stressed that there will be no changes to the current wording on the sequencing of policy changes i.e. that rates will not be lifted until asset purchase have concluded. As such, focus on rates may well take a back seat this time round.
- ASSET PURCHASES: Despite the December minutes release stating that guidance could be ‘revisited in the early stages of this year’, many feel that January is perhaps too early an opportunity for the Bank to unveil any major changes on this front with March seen as a more opportune time. HSBC state that a January adjustment is unlikely due to 1) disappointing inflation levels 2) the ECB will wish to avoid an ‘unwarranted tightening of monetary policy conditions. However, Pictet suggest that this meeting could see the removal of the ‘in terms of size’ option from their guidance.
- GROWTH: Unlikely to see much in the way of changes this time round with Pictet looking for current guidance to eventually change to ‘upside risks to the euro area growth outlook are building’ if the 2018 growth picture develops as expected.
- INFLATION: In-fitting with recent data releases, ING look for Draghi to maintain his existing dovish tone on inflation, pointing to still weak inflationary pressures whilst emphasising the disinflationary impact from the stronger EUR. However, UBS note that Draghi will most likely have to pay some acknowledgement to the recent climb in oil prices (currently 12% above ECB 2018 assumptions) and the potential impact on CPI going forward.
WHAT TO WATCH OUT FOR
- DISCUSSIONS ON THE FUTURE OF THE PSPP: As discussed above, any changes to guidance in the Bank’s statement are likely to come at a later date or be minor at this stage. As such, a bulk of the focus instead will be on what/if any hints Draghi delivers on discussions about concluding the PSPP. Last time round, Draghi tried to downplay that such discussions took place and will most likely try and do the same this week in order to avert a tightening of monetary conditions. However, Draghi will have a tough time batting away questions from journalists given the December minutes which could see the ECB President pressed on the timing and scope of changes in guidance. HSBC highlight that at the October meeting, ‘Draghi had said that QE would not have stopped suddenly, but at the December one he refused to answer a similar question’. Therefore, any follow up to this will be closely watched by markets in an attempt to assess how much sway/if any the hawks are having on the debate at the Bank with recent rhetoric from uber-hawk Hansson continuing to bang the drum for a sudden conclusion to purchases. That said, ultimately, Morgan Stanley don’t expect any major shift in guidance until March (alongside ECB staff projections) with a clear statement on the timing of purchases not expected until June. Note: markets will also be on the lookout for source reports in the aftermath of the press conference if some of the hawks view Draghi’s communications as too dovish or not representative of the discussions that took place.
- EUR EXCHANGE RATE: Another source of focus has been on recent EUR appreciation which has subsequently lead some of the bloc’s central bank heads to come out and comment on the matter. More specifically, the likes of Nowotny and Villeroy have suggested that the exchange rate must be monitored with Constancio adding that concern will only arise if movements in the EUR do not reflect market fundamentals. These comments were then followed up by source reports late last week suggesting that overall the ECB are relaxed about EUR appreciation. As such, the issue may not make it into the introductory statement but will likely be a topic of discussion in the Q&A (it is a rarity for the ECB to discuss the exchange rate in their introductory statement, additionally Draghi has often rebuffed questions on the matter by stating that the ECB does not target the exchange rate). If quizzed about the matter, Berenberg argue that Draghi is unlikely to raise too much alarm at this stage due to 1) the EUR only being 1.2% stronger than the rate used in December 2017 and 2) ECB calculations have shown that a stronger euro does not weigh on the Eurozone economy as much as in the past. Note, that if Draghi was to insert a comment on the EUR exchange rate into the statement, previous communication in September stated ‘the recent volatility in the exchange rate represents a source of uncertainty which requires monitoring with regard to its possible implications for the medium-term outlook for price stability’.
- COMPOSITION OF PURCHASES: Another issue that Draghi could be quizzed on or feel the need to comment on is this year’s composition of purchases with the Bank yet to clarify the breakdown of purchases throughout the year. Berenberg highlight that based on purchase data this year, ‘data for January so far suggests that the cut in the purchase programme has fallen largely, if not completely on sovereign bonds –if one were to extrapolate the weekly data to the whole month, from currently EUR 50bln monthly down to EUR 20bln in 2018, with EUR 10bln monthly for the sum of corporate bonds, covered bonds and ABS.’ Therefore, journalists may chose to press the President on this issue to see if it is representative of the Bank’s purchases going forward.
As ever with the ECB, markets can see multiple waves of reactions throughout the decision and press conference. As discussed above, two of the key factors for markets to look at are the future path of the PSPP and the Euro exchange rate. If Draghi avoids any mention of or bats away questions about the Bank’s intentions for curtailing purchases later in the year (possibly allied with a cautious tone on the Eurozone’s inflation prospects), markets could interpret this as a dovish factor and subsequently could lead to selling pressure in the EUR, with strength in fixed income markets and equities. Conversely, if Draghi tackles the issue head on and hints that announcements will come in March or that the hawks are having an increasing sway on the future path of policy at the bank, then the opposite reaction could be seen. If Draghi attempts to talk down the currency then this could naturally lead to some selling pressure in EUR (however, this will be subject to the broader tone of Draghi’s statement as his efforts to talk down the currency in September failed after he was simultaneously upbeat on inflation). Finally, as a reminder, watch out for source comments in the hours following the press conference.
WHAT THE BANKS ARE SAYING
- BARCLAYS: We do not expect any change in policy but we’ll scrutinize President Draghi’s comments on recent market developments and on the GC’s discussions regarding possible upcoming changes to the forward guidance, which we expect to happen at the April meeting.
- HSBC: The minutes of the December ECB meeting noted that language on the policy stance and forward guidance would be “revisited” in early 2018, raising the question of whether this could be as early as 25 January. With the news on growth since December again surprising to the upside and the latest oil price rise helping lift near-term headline inflation, Mr Draghi has come under increasing pressure to start preparing markets for the imminent end of QE. However, underlying inflation remains sluggish and the euro has appreciated. With the ECB still concerned that inflation may not return to target in a sustainable manner, we expect no change in policy or language in January, although the meeting is clearly going to be more exciting than previously expected.
- ING: We stick to our previous view that the ECB will not stop QE in September but will rather decide on another “lower for longer” beyond September, probably until the end of the year. Given that even the hawks are currently emphasising sequencing, a first rate hike will not be on the cards before mid-2019. Interestingly, the ECB has picked up the narrative from Draghi’s Sintra speech and is more and more focusing on growth, considering inflation only as a derivative of growth developments. For next week’s meeting, we expect Draghi to convey a rather dovish message, pointing to still weak inflationary pressure and also emphasizing the disinflationary impact from a stronger euro. The most important message to watch will be whether Draghi confirms the October statement that there will be no sudden end to QE. We expect him to do so as this would be the only way to – at least – temporarily get the genie back in the bottle. It would also show Draghi’s magic of how to guide financial markets with very few words and without any action.
- MORGAN STANLEY: This week’s press conference will likely deliver a balanced message. The forward guidance will evolve, but gradually. We expect the next change in March. We see no more QE from October this year and the depo rate rising in March 2019. Waiting for the signal: The first monetary policy meeting of 2018 is likely to be scrutinised closely by market participants for clues on when the central bank’s forward guidance will change once again – and how. This will likely happen in March, when we project inflation to start rising again and the new ECB staff projections are likely to show higher inflation. A more clear-cut indication that QE will end from October as we forecast is likely to come in June, we think. Language evolution: We doubt that the Governing Council has already decided how to communicate the next policy shift to the market. Apart from the tone and content of future press conferences and speeches/interviews, we see two possibilities. The first one is to make the QE easing bias more symmetric, by saying that the ECB stands ready to increase the horizon of the asset purchases if needed, but dropping any reference to a potential increase of their monthly size once again. A second way, perhaps after this step, is to make the programme closed-ended, by no longer saying that it could buy beyond September. The exit sequence: Once QE comes to an end, the central bank – towards the end of this year – will probably change the forward guidance on rates too, and indicate that the depo rate will move some time after the net asset purchases are discontinued, rather than a long time after. We expect the first 15bp depo rate hike to -0.25% in March 2019. The market has more or less converged to this long-standing view of ours, and we now believe that the timing of the first hike is ‘correctly’ priced.
- NOMURA: We are not expecting too much new information to emerge from next week’s ECB policy board meeting. The minutes from the December meeting surprised market participants in suggesting the Council plans to revisit the asymmetric nature of the forward guidance on QE early this year, sooner than was previously assumed. However, we think it more likely that the QE bias will be removed at the March meeting when the ECB will release its macroeconomic projections. Meanwhile, with recent inflation data subdued and a still high level of uncertainty about how tighter financial conditions might affect the economic outlook, we doubt whether the ECB will deliver further hawkish communications at present. Still, on a multi-month horizon we believe the region’s pace of growth and the level of inflation will surprise the ECB on the upside. And that will pave the way for a signal in the middle of the year that the APP will not continue beyond September. We believe that will then pave the way for some softening of the forward guidance on interest rates in Q3 and then a 10bp depo rate hike by the end of the year.
- NORDEA: The ECB is unlikely to change its guidance next week. We see some downside potential for the EUR and bond yields. The start of the year has been characterized by a lot of speculation that the ECB was about to turn towards a less dovish stance. The speculation only increased after minutes from the December meeting suggested the language pertaining to various dimensions of the monetary policy stance and forward guidance could be revisited early in the coming year (i.e. this year). We interpret the message from the minutes very differently compared to the reaction in financial markets. The ECB has long talked about the need for its communication to change gradually. There was ample discussion on changing the forward guidance already last summer, while some Governing Council members pushed for changing the guidance further already in October (the reference to lower rates in the forward guidance was dropped last June).
- RBC: We don’t expect the ECB to announce any major changes at its first meeting of 2018. That is despite the account of its December meeting saying that the ECB would make changes to its forward guidance ‘in coming months’. However, as we set out in our preview note, changes to the language are coming even if it’s difficult to pinpoint when. With the euro area economy humming along nicely and the threat of deflation having passed, the easing bias implied by elements of the current language seems increasingly obsolete. But, one crucial line in the accounts was that changes to the guidance would include what is currently said on the sequencing of policy changes. For that reason, we restate our current ECB call; we expect QE to continue to September as currently planned with a short taper of three months then taking purchases to the end of 2018 and rate rises coming only ‘well’ after that point, we think in Q3 2019.
- TD SECURITIES: We look for the ECB to keep its 12:45pm press release unchanged, despite the growing speculation that it could start changing the language as soon as this meeting. However, we don’t think that we’ve seen enough progress on inflation to justify a change. If we do see a change in March, we think that it will be in the reaction function rather than in the language that ties QE to inflation, and almost certainly not in the sequencing or reinvestment plans. For the January meeting, we look for Draghi to push back against EUR strength in the press conference, but think that it would take more EUR appreciation than what we’ve seen so far for the ECB to go as far as adding more EUR language into the opening statement.
- UBS: Bullish macro data, the recent hawkishly-perceived ECB minutes, an appreciating Euro, and higher yields and oil prices promise to make next week’s ECB meeting more interesting than previously anticipated. Indications are growing that the ECB will soon start to shift the focus of its communication away from QE and towards interest rates (forward guidance) as the key instrument to support the inflation recovery; this would also imply that the QE easing bias is becoming less important. While the focus on interest rate forward guidance is thus likely to increase, this in itself does not mean, in our view, that the first depo rate hike should be expected earlier than previously assumed – we still expect it for July 2019. Obviously, if the data were to remain strong, the ECB might eventually start hiking earlier, but this is not a decision it has to make soon – it can wait for another few quarters and then decide in a data-dependent way. Our monetary policy call is essentially unchanged: we expect the ECB to conduct monthly asset purchases of €30bn until September 2018, but then wind down QE. In light of very strong data, a final moderate extension of QE in Q4 2018 seems very unlikely by now. As before, we expect key interest rates to be hiked only after the end of QE, most likely as of July 2019; but we acknowledge that a continuation of very strong data could skew the risk towards a somewhat earlier rate hike.
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