No surprises from the ECB

LOcom_AuthorsAM-Arnaud.png   Charles St Arnaud
Senior Investment Strategist


No change to monetary policy

As was widely expected, the European Central Bank has kept its monetary policy unchanged, both in terms of the level of interest rates and the pace of the Asset Purchase Programme (APP). The ECB also reiterated the flexibility of its policy saying that “the Governing Council stands ready to increase the APP in terms of size and/or duration,” if needed.

This was broadly in line with market expectations. In terms of sequencing, the ECB continued to say that rates are expected to remain at their current level “well past the horizon of net asset purchases,” and that it “will reinvest the principal payments from maturing securities purchased under the APP for an extended period of time after the end of its net asset purchases.”


Future growth outlook healthy

The main focus in today’s meeting was the characterisation of the economic situation and the resulting changes to the ECB’s forecast. As such, the ECB notes that recent indicators continue to signal a strong pace of economic growth.  As a result, it upgraded substantially the growth outlook, with Eurozone GDP expected to grow by 2.4% in 2017 (2.2% previously), 2.3% in 2018 (up from 1.8%), 1.9% in 2019 (from 1.7%) and 1.7% in 2020.


Inflation not a major concern

On the inflation side, the outlook was revised higher but only for 2018 and not beyond, and comments from President Draghi at the press conference suggest that most of the upside revision to the inflation forecast is the result of higher energy and food prices. This suggests two important points, in our view:

  1. That the forecast for core inflation is likely to have been little changed
  2. That stronger growth is not expected to result in inflationary pressure. With President Draghi commenting that the output gap should be closed over the course of next year, this suggests either that the potential growth was revised higher or that the ECB does not believe in the Phillips curve (that is, the conventional understanding of the relationship between inflation and unemployment).


Our expectations remain unchanged but we are keeping a close eye

Today’s ECB meeting leaves us unchanged in our views in terms of the sequencing on the policy stimulus removal. As such, we continue to believe that the ECB will end the APP program in late 2018, with the risk of a 3-month extension as a result of continued weakness in core inflation, and that it will keep reinvesting maturing bonds afterwards. We believe the first rate hike will only happen once the APP program is over and is likely to happen in the first half of 2019, while the end of reinvestment (in other word, balance sheet reduction) is unlikely to happen until 2021. Nevertheless, the ECB remains flexible and the exact timing of any changes to monetary policy will remain dependent on the growth outlook, inflation and financial conditions.

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