What to expect from the European Central Bank’s April meeting

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The European Central Bank (ECB) will be meeting in Frankfurt on Thursday, with investors on the lookout for any signs suggesting the bank’s asset purchasing programme could be brought to an end later in the year.

At the ECB’s most recent meeting at the beginning of March, President Mario Draghi sent the Euro sharply lower, talking up downside risks while reiterating the need for policy accommodation. Draghi mentioned the risks stemming from a stronger Euro and threats from protectionism. The bank also issued a modest downward revision to its long term inflation forecasts, suggesting that it was in little hurry to begin considering the need for tighter policy.

We think that the European Central Bank will opt to maintain its fairly cautious tone with regards to future monetary policy at this month’s meeting. Recent macroeconomic data out of the Euro-area has been soft, since the last Governing Council meeting in March, while external risks, including the possibility of a global trade war, could be clouding the outlook.

Following its fastest period of expansion in ten years in 2017, the Eurozone economy appears to be stalling so far in 2018. The monthly business activity PMI data has been very underwhelming and, while remaining comfortably above the key level of 50, there are signs that overall growth could slow in the first quarter.  The composite PMI, which represents a weighted index of the manufacturing and services sectors, came in at just 55.2 in March (Figure 1). This marked its lowest level since January 2017, just two months after rising to a twelve year high of 58.8. Economic sentiment indicators have also shown that confidence in the Euro-area is weak, while industrial production has contracted in the past three consecutive months for the first time since 2012.

Figure 1: Eurozone PMIs (2015 - 2018)

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Source: Thomson Reuters Datastream Date: 23/04/2018

A development of even greater concern to policymakers at the ECB will be the lack of inflationary pressure in the Eurozone. Core inflation, the best predictor of future inflation, has been particularly soft, failing to breach one percent for the sixth straight month in March. There was a modest increase in headline inflation to 1.3%, although this also fell short of the 1.4% consensus and is still comfortably below the central bank’s ‘close to, but below 2%’ target. The recent slew of below forecast macroeconomic data in the Eurozone can be seen in Citi’s Economic Surprise Index (CESI), which has fallen sharply since March and is currently at its lowest level since June 2012 (Figure 2).

Figure 2: Eurozone Economic Surprise Index (2014 - 2018)

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Source: Thomson Reuters Datastream Date: 23/04/2018

 The central bank will not be upgrading its economic projections, including its growth and inflation forecasts, until the June meeting. We, at the very least, expect President Draghi to acknowledge the soft data witnessed during the first quarter, particularly the continued undershooting in core inflation. He may also note that the global backdrop has become less favourable since March, amid rising trade tensions between the US and China, and the ongoing uncertainties surrounding Trump’s presidency in general.

We also think that the ECB is in no rush to signal it is ready to remove its unconventional policy tools of negative rates and QE. The macroeconomic outlook has clearly worsened since the last meeting and the Governing Council will be wary of prematurely signalling a removal of stimulus for risk of causing a sharp upward move in the Euro. Policymakers remain broadly opposed to a strong currency, given its negative impact on the currency bloc’s export competitiveness.

In light of the recent macroeconomic news, we think that another short extension in the bank’s quantitative easing programme beyond September is now on the cards. We see a good chance that the programme could be extended until December 2018, which would include gradual reductions in the monthly purchases towards zero. As we have mentioned in the past, we think that an interest rate hike still remains way off, and a delayed QE exit could push back the timing of the first hike even further.

We do, however, believe that any concrete announcements on altering monetary policy remain a little way off and expect no change in forward guidance at this week’s meeting. The lack of any forward guidance and another dovish assessment from President Draghi could be seen as a disappointment to much of the market, which we think may pressure the Euro lower following this Thursday’s press conference.

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