Monetary tightening isn’t on the cards for the eurozone

Macro Highlights - 04-04-2017

Several dovish comments from eurozone central bankers this week confirmed that the ECB does not plan on halting its quantitative easing programme in 2017 and that it is premature to expect a rate hike in early 2018. The deceleration in eurozone inflation in March, which we expected, should help anchor inflation expectations that the ECB is likely to continue its accommodative monetary policy

As the European Central Bank (ECB) announced in late 2016, it will scale back its monthly asset purchases from EUR 80 billion to EUR 60 billion starting in April of this year. But eurozone central bankers have made many dovish comments recently in an attempt to reassure markets that the ECB doesn’t plan on halting its quantitative easing programme anytime soon, and, especially, that it doesn’t plan to raise interest rates in early 2018.

These comments were intended to calm expectations of a rate hike, which surged in March. For instance, on 28 February, Eonia futures contracts put the probability of a March 2018 rate hike at 15.2% – but that figure had soared to 71.4% by 24 March.

Two factors fuelled those expectations. First, the ECB press conference on 9 March during which Mario Draghi did not reiterate in his introductory statement that the ECB was prepared to use “all the instruments available within its mandate.” Even though Draghi later said the phrase was removed to indicate that there is no longer a “sense of urgency” regarding the risk of deflation, investors still took it as a hawkish signal. Second, comments made by Ewald Nowotny in an interview with German business daily Handelsblatt on 16 March that the ECB could decide to raise its deposit rate before it finishes its bond purchases. His remark seems even more hawkish considering that it contradicts the ECB’s forward guidance by which “The Governing Council continues to expect the key ECB interest rates to remain at present or lower levels for an extended period of time, and well past the horizon of the net asset purchases.”

In light of those developments, the ECB felt it was necessary to play down expectations of a forthcoming shift in monetary policy. On 29 March, a Reuters article citing anonymous sources at the ECB said that markets had “overinterpreted” the ECB’s statements at its 9 March meeting, and that those statements were simply intended to communicate a reduction in extreme risk but not that monetary policy would become less accommodative.

And on 27 March, Peter Praet said that not only was it “premature” to talk of the ECB ending its ultra-loose monetary policy, but also that there was “strong logic” backing up the forward guidance, which says that asset purchases would have to end before any rate hike.

These statements were successful in scaling back expectations of a rate hike in early 2018. By Monday, 3 April, Eonia futures contracts had put the probability of a March 2018 rate hike back down to 41.3%.

The eurozone inflation figures released at the end of last week might also have helped underscore the notion that the ECB will continue on its accommodative path.

As we had predicted, headline inflation fell in March because base effects from energy prices have starting to fade. The year-on-year increase in the Harmonised Index of Consumer Prices (HICP) slid from 2.0% in February to 1.5% in March, based on initial estimates. And core inflation edged down from 0.9% in February to 0.7% in March, confirming the absence of inflationary pressure in the currency bloc.

 

Analysis and implications

Recent comments by ECB members, as well as the dip in eurozone inflation that we anticipated, support our forecast that the ECB will maintain its accommodative monetary policy over the coming months. We also expect that:

  • The reduction in the ECB’s monthly asset purchases from EUR 80 billion to EUR 60 billion starting in April won’t trigger a substantial rise in eurozone bond yields. It has been shown that the stock of assets accumulated by central banks during quantitative easing – a stock which in the ECB’s case will continue to grow – exerts more downwards pressure on yields than the asset purchases themselves (i.e. the flows of purchases);
  • The ECB should continue buying assets at a pace of EUR 60 billion a month until end 2017;
  • Talk of ECB tapering won’t really heat up until the second half of 2017, once the major upcoming elections in Europe are over;
  • ECB tapering could start in the first half of 2018;
  • The ECB is unlikely to hike interest rates until its asset purchase programme has ended.