24 Apr 2017

ECB in holding mode as it waits for signs of a sustained move in inflation

Philip Shaw

Chief Economist

The European Central Bank’s (ECB’s) Governing Council (GC) holds its April meeting next week with the policy decision due at 12.45pm (UK time) on Thursday 27 April. President Draghi will give a press conference afterwards at 1.30pm (UK time), as usual.

We firmly expect no change to be made to the main policy rates with the main refinancing rate (refi rate) set to be held at zero, the deposit rate at -0.40% and the marginal lending rate at +0.25%. Note that QE purchases are now continuing at a rate of €60bn per month, having run at an €80bn per month pace prior to April; we expect the ECB to announce no changes to this.

We expect the ECB will aim to draft its introductory statement in such a way that it provides little new news for markets to grab on to when analysing it for hints of a change in policy direction. We expect the ECB to stand by its existing policy plan which foresees asset purchases continuing until year end or longer, whilst providing little by way of specific clues on the timing of rate moves ahead. Current ECB guidance states that ‘we continue to expect them [rates] to remain at present or lower levels for an extended period of time, and well past the horizon of our net asset purchases’; we expect no change to this. Further, the introductory statement is likely to maintain that if the outlook becomes less favourable the GC stands ‘ready to increase our asset purchase programme in terms of size and/or duration’ as it did in the last statement’.

Note that one reason for the ECB being especially guarded in its policy communications this time is that it appears to be in watch and wait mode on inflation. Headline Euro area inflation climbed to 2.0% in February but then slipped back again to 1.5% in March. Further, the ‘core’ measure continues to linger below 1%; Core HICP inflation (ex-energy and unprocessed food) was at 0.8% having held below 1.0% now for a full year. Noise in the March/April numbers, perhaps related to the timing of Easter, makes it challenging to know what the underlying picture is and whether inflation is set to track back towards the ECB target of ‘below, but close to 2%’, and even above it. In light of this it is not that surprising that President Draghi has recently noted that, before making any alterations to interest rates, asset purchases and forward guidance, the GC still needs ‘to build sufficient confidence that inflation will indeed converge to our aim over a medium-term horizon, and will remain there’.

One further complication for the ECB at this stage is that survey data in the Euro area for the first quarter of this year has been robust; the composite PMI rose to a near-six year high of 56.4 in March and averaged 55.6 in Q1 overall. So far this has not been reflected to the same extent in official data. With the ECB continuing on a stated policy path that takes it to year end anyway (asset purchases are set to continue at €60bn per month until at least December), it makes sense for the ECB to bide its time and further consider the underlying level of economic momentum and how this translates to the inflation outlook. We would expect President Draghi to recognise the upbeat survey data, but not to draw new lines between this and its policy stance.

Note finally that next week’s ECB gathering will take place just a few days after the first round of the French election. We would expect the ECB President to be asked about the market implications of this, particularly if one of the more anti-EU candidates, Marine Le Pen (Front National, far right) or Jean-Luc Mélenchon (La France Insoumise, far left) makes it through to the second round vote on 7 May. Note though that President Draghi has remained relatively sanguine about the economic consequences of European elections this year. The recent ECB Annual Report said that, although political uncertainty is likely to persist into 2017, the ECB remains confident that the economic recovery will continue. It is likely that President Draghi will hold this line.