Whattup, fellas! On Thursday at 12:45 pm GMT the European Central Bank (ECB) will publish its monetary policy decision for the month of January. A presser will then follow an hour later at 1:30.
Think you’re ready to trade the event? Let’s have a quick review of what happened last time and what market players are expecting from the central bank this time around.
What happened last time?
- Key interest rates like refinancing rate (0.00%), marginal lending rate (0.25%), and deposit rate (-0.40%) remain unchanged as expected
- Asset purchases to be reduced to €30 billion per month from January until the end of September 2018
- Draghi: price pressures remain muted
- Draghi: “ample” degree of monetary stimulus remains necessary
As expected, the ECB kept its monetary policies unchanged in December. Key interest rates remained steady at their current levels (see bullets above).
The Governing Council also stuck to script when it repeated that members expect rates “to remain at their present levels for an extended period of time, and well past the horizon of the net asset purchases.”
Meanwhile, asset purchases were re-affirmed at a pace of 60B EUR. However, ECB also noted that the monthly pace will slow down to 30B EUR starting January “until the end of September 2018, or beyond, if necessary.”The presser that followed was a little bit more eventful. For one thing, Draghi admitted that growth momentum suggests that inflation could pick up, enough for them to be confident that inflation will eventually hit their 2.0% target.
Draghi also shared staff projections that were more optimistic compared to their September numbers. Real GDP was expected to hit 2.4% in 2017, 2.3% in 2018, 1.9% in 2019 and 1.7% in 2020.
As for inflation, prices are expected to hit to 1.5% in 2017, 1.4% in 2018, 1.5% in 2019 and 1.7% in 2020 to reflect higher oil and food prices. However, Draghi also warned against foreign exchange movements and that “measures of underlying inflation have moderated somewhat recently.”
The biggest record scratch moment was when Draghi downplayed tightening expectations. He shared (emphasis mine):
“We say price pressures remain muted and have yet to show convincing signs on a sustained upward trend. So the conclusion is: 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. So, no change all throughout.”
As Pip Diddy noted in his weekly recap, the surprisingly firm statement about not making changes to the ECB’s language and intentions attracted a lot of bears that dragged the euro lower, at least until the end of the day.
What’s expected this time?
- No changes in key interest rates
- No changes in short-term forward guidance
- ECB to start redirecting focus from asset purchases to other monetary tools?
- Hints at future changes in language and direction
Market players aren’t expecting any monetary policy changes from Draghi and friends in January. And since they’ve just shared their latest economic estimates last month, it’s unlikely that we’ll hear any changes to their projections either.
Forward guidance is another story, however. See, despite Draghi’s insistence that the ECB’s language and intentions haven’t changed, a few clues have told us otherwise.
ECB’s December meeting “minutes,” for example, showed us that:
“…stronger than expected expansion of the euro area economy had further reduced the likelihood of adverse economic outcomes and, hence, had bolstered the Governing Council’s confidence in the eventual attainment of its inflation aim.”
This led members to believe that:
“…communication would need to evolve gradually, without a change in sequencing, if the economy continued to expand and inflation converged further towards the Governing Council’s aim.
The language pertaining to various dimensions of the monetary policy stance and forward guidance could be revisited early in the coming year.”
In the same document members noted that “changes in communication were generally seen to be premature at this juncture,” and that they should avoid “signals that could trigger an unwarranted tightening of financial conditions.”
Instead, it’s more likely that Draghi and his troops will focus on drawing focus away from asset purchases and into other monetary policy tools. All while emphasizing their confidence over rising inflation, of course.
Governing Council member Ardo Hansson himself hinted of such change in tone when he said as late as last week that
“There are certainly good reasons to reduce the importance of the net purchases in our communication soon — also with a view to a potential end to these purchases.”
Based on the clues above, we know that:
- Analysts aren’t expecting monetary policy changes this month;
- ECB members want to continue communicating their confidence in rising inflation rates;
- They don’t want “unwarranted tightening” that comes with changes in communication, and
- They’ll likely put less importance on asset purchases and more attention to other tools (read: interest rates) in their next announcements.
If Draghi sticks to emphasizing the downside risks to inflation and repeats that their language hasn’t changed, then it signals that the ECB is uncomfortable with markets pricing in tightening down the road. This could lead to the euro losing some its gains from the last couple of weeks.
If he chooses to shrug off the euro’s uptrend and confirms that, yes, he and his team are thinking of taper their asset purchases further, then we could see the common currency register new 2018 highs against its major counterparts.
But if he affirms plans to taper asset purchases AND spotlights downside risks to growth and inflation, then we might see a bit of euro selling that could last for a couple of candlesticks before traders move on to pricing other market catalysts.
Hope these tidbits help in making your trading plans!