An inconvenient recovery

The ECB signalled a gradual reduction of QE after positive data for the Eurozone’s economy. Morgan Stanley foresees balanced risks, Berenberg believes that the ECB will gradually phase out asset purchases from January 2018 but Berlin is still not happy. Ifo called the ECB to stop its QE immediately.

After Draghi’s press conference last Thursday, the Ifo president Clemens Fuest stated that he regretted the ECB’s recently announced decision. “It would be better to further scale back bond purchases as of May. We are expecting an inflation rate of just below two percent in Germany and the euro area for 2017. This is an indication that it is time for the European Central Bank (ECB) to start phasing out its expansionary monetary policy in Europe. It should now take its foot off the gas and scale back its bond purchases by 10 billion euros per month,” warned Fuest. “That means scaling back purchases to 50 billion euros in May, 40 billion euros in June and so forth.” As of April, the ECB will be spending 60 billion Euros a month on bond purchases to boost inflation towards the two percent marker, his statement concluded “The ECB should stem this flood of money or run the risk of overshooting its target,” Fuest added.

Fuest explained the logic behind his call for lower bond purchases as follows: “Company surveys by Ifo show that a growing number of firms plan to raise their prices in the months ahead. The results point to a core inflation rate (excluding energy) of around 1.5 percent this year in Germany. And the effect of energy prices will boost this figure. Inflation is increasing in Germany and in Europe, while companies’ price expectations in the Eurozone as a whole are also on the rise.”

However, Morgan Stanley reported that the ECB had set the stage for a gradual process in which the stimulus gets dialled down. In the context of more nuanced forward guidance, Morgan Stanley expects its risk assessment to become more balanced, rather than skewed to the downside, and a further reduction in the monthly QE purchases.

“We think that the ECB is done with adding to the stimulus, even if it continues to keep its options open. Not only will the monthly QE purchases diminish from April, as already announced. But, also, we expect the Governing Council to tighten the language, possibly at the June meeting, by describing the balance of risks as symmetric, and no longer with a negative skew. In September, if the outlook plays out as we expect, the ECB will likely announce a further reduction in the monthly purchases, to start in January. The central bank is playing for time. But it’s only a matter of time, in our view”, Morgan Stanley said.

Berenberg expects the ECB to gradually phase out asset purchases from January 2018 onwards and start raising its main refinancing rate in September 2019. The bank sees the current modest tweaking of the ECB’s rhetoric as a precursor to a shift from an easing bias to a neutral bias in June, possibly coupled with an easing of the ECB’s penalty rate on bank deposits at the ECB from -0.4% to -0.25%. When asked – like in January – whether the ECB would rule out hiking rates before the end of the asset purchase programme, ECB president Draghi de facto dodged the question again.

Holger Schmieding, chief economist at Berenberg, highlights some key points of the ECB’s upgraded assessment. The modestly more positive outlook shows up in many ways:

  • The ECB upgraded its economic outlook for 2017 (from 1.7% to 1.8% GDP growth) and 2018 (from 1.6% to 1.7%) and its projections for headline inflation in both years. Crucially, however, the ECB did not change the outlook for 2019, that is, for the year in which any monetary policy decisions taken now could be expected to show their full impact.
  • The ECB now sees a “steadily firming recovery” with a good chance that the “cyclical recovery may be gaining momentum”.
  • While the ECB maintained the view that the risks to its growth outlook “remain tilted to the downside”, it now regards these downside risks as “less pronounced” than it did before.
  • As a signal that the urgency for monetary accommodation had fallen, the ECB dropped the sentence in the introductory statement that “if warranted to achieve its objective, the Governing Council will act by using all the instruments available within its mandate”.
  • The ECB did not announce a new (third) round of TLTROs. TLTROs offer very favourable long-term funding conditions to banks to encourage lending to the real economy. The current, second round of TLTROs runs out this month.

Image: © ECB

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