The BOJ isn’t the only central bank that will be announcing its monetary policy decision this week since another ECB statement is also coming our way this Thursday (July 20, 11:45 am GMT).
So, what happened in the previous ECB statement and what can we expect from this event?
What happened last time?
- ECB maintained refinancing rate at 0.00% as expected
- ECB maintained marginal lending rate at 0.25% as expected
- ECB maintained deposit rate at -0.40% as expected
- QE extension until December 2017 (or beyond) at €60B per month maintained
As expected, the ECB announced during the June ECB statement that it wasn’t budging from its current monetary policy, so rates were all unchanged and the ECB affirmed that it was maintaining the pace of its QE purchases to boot.
However, the ECB’s official press statement conspicuously removed the phrase that rates may be slashed “to lower levels.” And that implied that the ECB no longer has a cutting bias on interest rates, which is very likely why the euro’s initial reaction was to try and jump higher.
Unfortunately for euro bulls who were late to party, a Reuters report (that cited unnamed ECB sources) from a week earlier already gave attentive forex traders a heads up, so euro bulls who got in early likely used that opportunity to take some profits off the table. Basically, a “buy the rumor, sell the news” kind of scenario.
Furthermore, the ECB retained the phrase that it “stands ready to increase the programme in terms of size and/or duration,” which implied that the ECB still has an easing bias on its QE program.
As such, euro bears later began to win out and euro pairs started to tilt to the downside ahead of the presser.
And when the ECB presser did roll around, ECB President Mario Draghi confirmed that the ECB no longer has an easing bias on interest rates but still has an easing bias on its QE program. Draghi even said that the ECB is ready and willing to switch back to an easing bias on interest rates when he said the following (emphasis mine):
“The other point was about why we left the other bias, the APP [asset purchase program or QE program] bias, easing bias. Well, first of all, the two are very different. The first is an expectation that interest rates will remain at present or lower levels. Now, if you ask me now, ‘What do you expect?’ I would say that based on a current assessment, current information, I don’t expect lower interest rates. If you ask me, ‘But in case things were to worsen, are you ready to lower interest rates?’ the answer is yes. So the APP easing bias is like this. It’s part of a reaction function and it does say that if things were to turn less favourable – and here, just stop a moment: if things were to turn less favourable, it’s a set of contingencies which is more benign than the tail-risk contingency embodied in the expectation on rates, and as such it’s still there. So it’s part of our reaction function. If things turn out to be less favourable we are ready to expand our APP. That’s the answer.”
Aside from that, Draghi also revealed that the ECB upgraded its GDP growth projections while downgrading its inflation projections. And since the ECB’s monetary policy hinged on inflation, forex traders took the downgraded reading as a sign that the ECB isn’t budging from its current monetary policy anytime soon, which is likely why the euro continued to trade broadly lower until the end of the day.
What are analysts expecting?
Reading up on the prognostications by analysts at MNI and analysts from the Big Banks, the general consensus seems to be that the ECB will not make a policy move on Thursday, but the ECB is expected to do something to reinforce Draghi’s hawkish June 27 speech at Sintra.
And the widely expected move is that the ECB will make tweaks to its language to remove (or signal a removal) of its easing bias on its QE program. However, the ECB is also expected to emphasize that it has no plans to taper its QE program just yet.
How is the Euro Zone economy faring?
Let’s take stock of the most recent economic data and compare them with the ECB’s economic forecasts as of the June meeting.
First up is headline HICP and it unfortunately eased to 1.3% year-on-year in June, which is the weakest reading in six months and a miss from the ECB’s forecast of 1.5%.
It’s also veering away from the the ECB’s 2017 forecast of 1.5% and is even below 1.4%, which is the lower bound of the ECB’s forecast range.
Even so, the weaker reading was due mostly to weaker energy prices (thanks to lower oil prices), which was foreseen by the ECB. Moreover, if energy prices are stripped, then HICP actually improved. In fact, the most recent reading for HICP stripped of energy prices is back on track to meeting the ECB’s year-end forecast of 1.2%. The reading for HICP less energy and food prices, meanwhile, already exceeds the ECB’s forecast of 1.1%.
As such, underlying inflation is still playing out within the ECB’s expectations. And remember, the ECB retained its easing bias on QE because it was not sure that the recent rise in inflation is sustainable. But since underlying inflation is still in-line with the ECB’s forecasts, it is highly unlikely that the ECB would turn more dovish during the upcoming ECB statement.
Moving on to GDP growth, the ECB expects the Euro Zone economy to grow by 1.9% year-on-year in 2017, since exports and gross fixed capital formation are expected to pick up.
And since the final estimate for Q1 GDP growth came in at +1.9%, then that means that GDP growth is currently on track to hit the ECB’s forecast.
Moreover, gross fixed capital formation surged by 6.0% in Q1 2017 (+5.1% previous), which is a very promising start for 2017 and a good sign for the Euro Zone’s longer-term economic potential. Exports are a bit lackluster, though, printing only a 2.1% increase in Q1.
As for the labor market, the ECB forecasts that the jobless rate will come in at 9.4% by the end of the year.
And so far, the Euro Zone economy is beating that since the reading for June came in at 9.3%, which happens to be a shared lowest reading since March 2009.
Overall, the Euro Zone economy (as a whole at least) is still evolving in-line with the ECB’s forecasts, with the exception of the miss in headline HICP. As such, the ECB is highly unlikely to become more dovish based on the recent economic developments. However, the miss in headline HICP does mean that the ECB will be more likely to retain its easing bias on its QE program.
What have ECB officials been saying?
I mentioned Draghi’s June 27 speech at Sintra earlier. And aside from Draghi’s upbeat assessment and outlook on the Euro Zone economy, the parts that were interpreted as hawkish are as follows (emphasis mine):
“As the economy continues to recover, a constant policy stance will become more accommodative, and the central bank can accompany the recovery by adjusting the parameters of its policy instruments – not in order to tighten the policy stance, but to keep it broadly unchanged.”
In addition, we now know from the minutes of the June ECB meeting that ECB officials discussed the possibility of removing their easing bias during the June meeting. However, they chose not to do so because they were not sure that inflation is on a sustainable path.
Of course, there were dovish views as well. ECB Vice President Constancio said during a June 29 CNBC interview, for example, that he’s worried that the slack in the Euro Zone economy may be greater than what the ECB’s indicators are showing since wage growth remains subdued, which is why Constancio believes that the ECB has “to persist in the type of monetary policy that [the ECB has] been adopting.”
More recently, ECB Member Francois Villeroy de Galhau expressed the same view when he said that “there is still a need for our accommodative monetary policy.”
However, a Wall Street Journal report (that cited unnamed ECB sources) alleged that Draghi will supposedly participate in the Fed’s Jackson Hole Summit in August. And Draghi will supposedly use that event to express “a further sign of the ECB’s growing confidence in the eurozone economy and its reduced dependence on monetary stimulus.”
If that Wall Street Journal report is the real deal, then perhaps ECB officials are more hawkish than they’re letting on. And Draghi may potentially give some hints on that during the upcoming ECB meeting and presser, which may give the euro a boost.
Do note, however, that the COT report has been showing that large players are heavily net long on the euro versus the Greenback. This has more to do with Greenback bulls running away and/or euro shorts punching out, rather than fresh euro longs jumping in, so profit-taking by euro longs on a “buy the rumor, sell the news” scenario is probably unlikely.
However, if Draghi disappoints by sounding more dovish or presenting a bleaker outlook on the Euro Zone economy, then those euro shorts that have left and are now in the sidelines may decide to jump back in, which will likely push the euro lower. But on the upside, fresh euro bulls haven’t been piling in yet and there are still a lot of euro shorts, so it’s possible that the euro may get a bullish boost if Draghi does decide to present a more hawkish tone.