In his speech in Sintra that was held at the end of the June, Mario Draghi expressed optimistic rhetoric regarding future inflationary movements by stating that the threat of deflation is gone and reflationary forces are at play. Such bullish assessment on the Eurozone outlook again increased market’s speculations that the ECB might opt for monetary stimulus withdrawal sooner than expected. However, just a day after Draghi's speech, certain senior officials at the ECB stated that investors had misunderstood and over reacted to the Mario Draghi’s speech.
The ECB Council meeting is scheduled for this Thursday and it is the first time that the Council meets after the Draghi’s upbeat speech in Sintra. So what can we expect from the meeting?
Since the last ECB meeting, both the soft and hard data releases have showed that the economic activity in the Eurozone is expanding. The Council will probably acknowledge that economic activity is improving further and that output gap is closing somewhat faster than anticipated. The latest consensus forecast from the Survey of Professional Forecasters should be available for the Council meeting and will probably support the view of further strengthening of the Eurozone economy.
It is worth noting that the Council is under substantial pressure at this meeting. First of all, after the hawkish Draghi statements in Sintra, it doesn’t make much sense for the Council to be dovish at this meeting. On the other hand, some Council members might be reluctant to give further exit signals as they consider that the signals that were already given triggered exaggerated market reactions. Last but not least, the bond purchasing programme will reach its limits at the beginning of the next year if purchases are not reduced from the current level of EUR60bn per month.
All in all, the Council will probably try to balance its rhetoric toward very gradual exit but without any concrete decisions. After dropping out the easing bias on rates in June, the Council will probably remove the possibility of increasing monthly bond purchases if required from its statements. The latter will be a signal of the expected tapering that is expected to be announced in September as the Council said that it wants to decide about 2018 policy outlook no later than October.
Regarding rates, the Council will keep its view that interest rates will stay around currently low levels long after the bond purchases program ends. Therefore, the market should drop out the speculations about an early rate hike.
However, the ECB clearly stated several times that an early rate hike is not an option, at least not from the current point of the view. The market on the other hand was far more focused on the optimism expressed about growth and inflation. In such circumstances, euro appreciated strongly and 5 and 10-year yields on Bund increased significantly in the recent period. Therefore, I believe that the ongoing optimism regarding growth and gradual announcement of the tapering in the coming months should be enough to provide further support for the euro in the short term. The latter is especially the case versus the dollar as the market interpret recent Fed’s rhetoric quite dovish.
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