02 Mar 2017

ECB Preview: ECB to remain on hold, as inflation heads above target

Philip Shaw

Chief Economist

Next Thursday (9 March) sees the ECB announce its latest policy decision at 12:45 (GMT), followed by President Draghi’s press conference at 13:30. We expect no change in policy with the main refinancing rate held at 0.00%, the deposit rate at -0.40% and the marginal lending rate at +0.25%. Additionally we expect no change in the ECB’s QE programme (€80bn currently and €60bn from April)

Whilst the actual policy announcement is unlikely to yield any fireworks, interest is likely to centre on the ECB’s analysis of the economic backdrop, including the ECB staff macroeconomic projections which will also be released. Since the last ECB Governing Council (GC) meeting on the 19 January economic data has generally outperformed expectations. The Composite PMI has firmed to 56.0, its highest level since April-2011 and if sustained at this level in March would signal q/q growth of +0.6%- 0.7% in Q1, according to the survey provider Markit. We are forecasting GDP growth picking up to +0.5% in Q1 from +0.4% in Q4 2016 and 1.8% for 2017 as a whole.

Headline inflation has also surprised to the upside in recent months, with February HICP inflation recorded at 2.0%, above the ECB’s target of ‘below, but close to 2%’ and the firmest outturn since January 2013. It is also a far cry from the -0.2% seen last February. However, much of this rise in inflation has been driven by energy price effects, as evidenced by the still relatively subdued core inflation numbers (+0.9%). Nonetheless, inflation outturns have been firmer than the ECB’s projections, with both President Draghi and Bundesbank President Jens Weidmann having suggested that the December inflation projections may need to be revised up. Indeed Weidmann this week suggested that 2017 HICP inflation could be pushed up by 0.5ppt, which could push the 2017 inflation forecast to 1.8% next week.

We suspect that the President’s opening statement will acknowledge the better news on economic activity, as well as the pick-up in inflation. Although we suspect the ECB will stick to its view that the rise in headline inflation is largely transient and something which it will look through; Particularly in light of the lack of a clear uptrend in core inflation, which has remained in a 0.7%-1.0% range for the last 16 months. However, what we do see as a possibility is that the GC revises its assessment of the downside risks to the outlook, acknowledging that they have receded (although still tilted to the downside). Especially given January’s statement highlighted the downside risks as being predominantly global in nature, where if anything information over the last month has pointed to a pick-up in global growth.

Despite the better economic news and headline inflation above the ECB’s target, a change of ECB policy is still too early to contemplate. Our central forecast is for QE to continue as planned until the end of 2017, although we would expect a tapering announcement in Q4. However with the outlook firming, one issue the ECB might need to address sooner rather than later is its communication on interest rates. The current guidance is that the ECB expects key interest rates “to remain at present or lower levels for an extended period of time”. However, given the fundamental backdrop removing the “lower levels” line would seem appropriate. Next week might be too soon, but we would expect the guidance to change within the next few meetings, effectively taking the first step away from its current ultra-loose stance of policy.

Whilst we do not expect any change in policy next Thursday, the ECB may need to outline a few technical details on its Asset Purchase Programme. From April the pace of ECB QE purchases is set to step down to €60bn a month, as announced in December. However, since then there has been no explicit guidance on how the programme would be scaled down. President Draghi was asked in January whether the move down to €60bn from €80bn would simply be pro rata, but at the time he replied it had not been discussed. So with this the last meeting before the change in pace there is the possibility that the President provides a little more clarity.

Finally a couple of other points may receive some interest during the President’s press conference.

  • Firstly Greece is undoubtedly likely to feature given the continued wrangling over its latest bailout review, the IMF’s involvement and medium term debt relief.

  • Secondly the issue of liquidity in the German bond market may also raise its head again. Over the last month, 2-year German bonds have surged, pushing yields to a record low -96bps. Part of the reason is demand for short dated German bonds for use as collateral, where the situation is unlikely to have been helped by ECB purchases of short dated German bonds in the last month. The ECB attempted to ease the situation in December by making its bond holdings more available under its securities lending programme, but clearly issues still remain.