Wednesday 08, March 2017 by William Mullally

European Central Bank not ready to signal policy tightening

The ECB will reject tapering fantasies for the time being despite higher inflation and a noticeable inflation forecast revision, writes David Kohl, Chief Currency Strategist and Head Economist Germany, Julius Baer.

In the US, the Federal Reserve is getting ready to hike rates again at its next meeting in March. In the eurozone, we expect the European Central Bank (ECB) to resist the trend for the time being and stick to its ultra-loose monetary policy stance at this week’s meeting. Most recent inflation figures will be the key challenge for the ECB’s loose monetary policy stance. Eurozone inflation reached 2 per cent in February and the ECB inflation forecast of 1.3 per cent for 2017 looks rather outdated. A noticeable upward revision to 1.9 per cent is foreseeable and should stir the debate if it is advisable to reduce monetary stimulus by reducing the volume of asset purchases or to end the negative deposit rate regime. We expect the ECB to strictly reject these tapering fantasies for the time being.

To some extent the ECB’s hesitation is understandable, not so much because of the policy uncertainty in Europe but rather due to the fact that the surge in inflation is driven exclusively by higher energy prices, which are raising serious doubts about the sustainability of this return of inflation. The core inflation rate has barely moved in the past two years and wage inflation remains moderate at around 1.4 per cent. Meanwhile, the Federal Reserve’s readiness to hike rates at its 15 March meeting has increased. Good economic data and signals from a number of Fed officials have pushed implied probabilities of a rate increase above 90 per cent. This divergence of monetary policy is again becoming a major support for the USD, which is expected to resume its upwards trend. The tapering fantasies when it comes to ECB policy alleviate the pressure on the euro and we expect only minor weakening over the next three months.

 

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