ECB Preview: A Long Road Ahead

The ECB are expected to stand pat on rates this week, according to surveyed analysts with markets currently pricing in around a 25% chance of a 10bps rate reduction at the first meeting of 2020; note, less than 3bps worth of loosening is currently priced in throughout the year. Focus for the press conference will center around the upcoming strategic review and how policymakers at the Bank evaluate the Eurozone’s growth prospects in lieu of recent macro developments.

Below we present a summary preview of what to expect from today’s ECB announcement, courtesy of Christopher Dembik of Saxobank

• For the first meeting of 2020, we don’t expect to see any changes in policy stance as the macro outlook is broadly unchanged compared to the end of 2019 in the eurozone. There is a wide consensus that the ECB is on hold throughout 2020. Risks to growth in December have moved downward while the 5-year, 5-year forward inflation expectation rate, which has always been monitored closely by Mario Draghi, continues to show signs of improvement (currently at 1.3% vs 1.1% a few months ago). Macro-stability will allow the ECB to focus on the launch of the second strategic review in the 20-year history of the organization that is expected to last one year.
• At 15:30 today, we may have a document revealing the main “parameters” of the review. As far as we know, the ECB plans to split the review into two parts: (1) ECB’s performance since the last review in 2003 and review of the framework, the instruments and the way inflation is measured and (2) financial stability, communication and climate change.
• The ECB review should revive a very old debate about the way to track inflation. The ECB, under Draghi’s leadership, seemed in favor of including housing prices in HICP but, in 2018, the EC advised against it due to the lack of timeliness of the new OOH Index (Ower-Occupied Housing Index). Any change in order to include housing prices could prove super hawkish. More basically, the review might also bring some clarity about what the objective of inflation really means. It could get rid of the “below, but close to” 2% inflation target and it could adopt a more flexible approach, i.e. a range of 1-3% for instance.
• Based on a strict interpretation of the Treaty, the ECB can play a role to protect the environment. We believe the likelihood it launches some kind of “Green QE” is high in 2021. The ECB has mostly three options at its disposal: (1) favoring green bonds as part of the revived QE programme, (2) applying a punitive haircut to bank collateral assorted to high carbon intensity activities and (3) targeting transition bonds for dirty companies that try to become greener.

The size of the #ECB balance sheet v #inflation: zero correlation! pic.twitter.com/G7dyvyTfAF

— jeroen blokland (@jsblokland) January 23, 2020

And a more details preview from RanSquawk

PREVIOUS MEETING: Rates were unchanged, in line with expectations, and the ECB’s policy statement was also little changed. President Lagarde provided a balanced assessment, largely sticking to the ECB’s script; but there were a few interesting remarks. Lagarde noted that while risks remained tilted to the downside, they were somewhat less pronounced given the stabilisation in data. Analysts also said she did a good job of assuring markets that the ECB was not on the cusp of a hawkish tilt. While she is pleased that inflation is moving in the right direction (noting that in Q4 2022, HICP is forecast to be sitting at 1.7%), she seemed displeased that it was not at target. She also appeared to suggest that the central bank’s mandate will not be changing from price stability, but is very aware of the side effects of negative rates, which she said was a ‘preoccupation’. Crucially, Lagarde was asked about the reversal rate (the point at which expansionary policy becomes contractionary), and she did not believe that the ECB was near it yet. Lagarde was again asked about her policy stance, batting away the question by suggesting she was neither a hawk nor a dove, and she wanted to be an ‘owl’. Lagarde was asked about unity on the Governing Council, and she said that she  was aiming for decisions to be as consensual as possible, in line with reports heading into the confab.

RECENT DATA: Since the previous meeting, December flash inflation metrics saw headline CPI picking up to 1.3% from 1.0% with the ex-food and energy print remaining at 1.4%; the rise in the headline was largely attributed to energy price effects. From a growth perspective, there has been little in the way of fresh evidence for the Q4 outturn (flash EZ GDP released on 31st Jan) other than the FY 2019 German GDP print which showed growth slowing to 0.6% from 2018’s 1.5%; Pantheon Macro noted that based on the FY reading and allowing for rounding Q4 GDP will print around 0.1-0.2%. Survey data has perhaps been of greater interest with December Markit PMIs showing the Eurozone-wide composite reading ticking higher to 50.9 from 50.6, however, the differing performances of the services and manufacturing sectors remains a key feature of the bloc’s outlook. Note, the January PMI report will be released the day after the ECB policy announcement.

RECENT COMMUNICATIONS: Given the Festive period and “wait and see approach at the Bank”, rhetoric by policymakers has been relatively limited. ECB President Lagarde at the beginning of the year noted that it “makes sense” for the Bank to use all of the tools at its disposal when it comes to increasing growth, which will also result in inflation moving towards levels close to 2%, adding that the biggest threat to the economy is a downturn in trade activity. On the hawkish end of the spectrum, in the immediate aftermath of the December meeting, Austria’s Holzman said  he is looking for a potential increase in the ECB’s deposit rate in 2020 in the event that the inflation trough passes during 2020, whilst Netherland’s Knot stated that “the balance between positive and negative effects of low interest rates is shifting in the wrong direction”. Elsewhere, the upcoming strategic review has also been referenced by various members of the Governing Council with Germany’s Schnabel noting “the (inflation) target worked very well in the past but structural changes in the economy justify a careful discussion”, whilst Villeroy of France has stated “our inflation target must be symmetric. If the central target is seen as a ceiling, we have less chance of meeting it”.

THE CURRENT BAR TO POLICY ADJUSTMENTS: Despite some stabilisation in EZ data, the signing of a phase one trade deal between the US and China and some near-term declines in Brexit-related uncertainty, policymakers look unlikely to make any adjustments on the policy front this time around. From a data perspective, the services sector continues to resist any spill-over from the contraction in manufacturing, however, policymakers will likely want further evidence that the Eurozone economy is “bottoming out” and inflation is seeing a meaningful pickup; a view shared by Danske Bank who have suggested the ECB has nothing to gain from being “proactive”, rather than waiting for more evidence that the Euro Area recovery is strengthening. As such, Danske believe that January will not see the Bank change their growth assessment to a “balanced” view following the December adjustment which noted that downside risks have become “less pronounced”. On the trade front, despite the signing of the phase one deal between the US and China, some tariffs between the two nations remain in place and will serve as a headwind, with phase two talks not expected to begin until after the November US Presidential election. Of greater concern for EZ policymakers comes from the direct threat of US tariffs on the bloc with President Trump to set his sights on addressing trade imbalances between the two regions; a move that could eventually hamper the Eurozone’s auto sector. Additionally, despite the near-term certainty bought around by the Conservative December election victory, the refusal by the Johnson government to extend the current transition period beyond December 2020 has led to heightened fears of a less-favourable outcome in EU-UK trade talks. With this in mind, the ECB are widely perceived to be in “wait and see mode” at the January meeting.

THE ROAD AHEAD: With the January meeting set to see policy settings unchanged, looking further ahead, markets currently price in around 1.65bps of loosening by year-end with the bias for rates being to the downside; note, in December President Lagarde suggested the Bank is not near the reversal rate (therefore, there is scope for rates to be lowered further). In terms of house calls, Capital Economics look for a 20bps rate cut in September to coincide with a EUR 10bln increase to the ECB’s monthly asset purchases (via corporate bonds); cites an easing of core inflation in the coming months. UBS’ forecast looks for a 10bps cut to the deposit rate in March. Rabobank suggest that the “cracks in the US economy” could force the hand of the ECB to cut rates in June. ABN AMRO look for a 10bps cut in the deposit rate, an increase in asset purchases by EUR 20bln and an increase in upcoming TLTROs to be announced in March. Oxford Economics look for policy to remain on hold throughout the year, however, suggest that structurally low inflation will remain a “permanent headache”.

TIMING AND FOCUS OF THE STRATEGIC REVIEW: With policy set to remain on hold, a key source of focus instead will be on the technical aspects of the ECB’s policy approach; namely, the upcoming strategic review due to be announced this week. Last week, reports suggested that President Lagarde has requested that policymakers refrain from making public comments before the upcoming review and therefore details are relatively limited thus far. However, a recent survey conducted by Bloomberg News showed that 90% of respondents believed that the ECB will adopt a more symmetrical approach to inflation targeting (equal weighting between too-low and too-high inflation), whilst half of respondents believe that the current goal of “below, but close to, 2%” will be made more precise. The review will likely focus on several key areas: 1) inflation target, 2) inflation measure, 3) communication strategy, 4) role in addressing climate issues. Tempering expectations for this week’s release, Capital Economics forewarns that those expecting to see the specifics on the scope and timetable of the review, might be disappointed. In terms of a timeline going forward, HSBC (last year) speculated that such a review could take 3- 6 months and ultimately lead to “fairly minor” tweaks on the basis that limited firepower for the ECB’s monetary policy could see them fall short of any potential new mandate and thus lose credibility. Oxford Economics believes that the review could last up to a year on the basis that Lagarde has pledged to leave “no stone unturned”.

FISCAL POLICY: As has been a common theme already during Lagarde’s leadership at the Bank and given the perceived limited room for further monetary policy, the ECB Chief will likely continue to bang the drum for assistance on the fiscal front. Deutsche Bank suggest that coordination of fiscal and monetary policy will likely prove to be more effective than the latter on its own, adding that “fiscal easing targeted at infrastructure spending could boost trend growth expectations and hence raise r*”. However, as it stands, there has been little evidence of Eurozone governments engaging on this matter, whilst Deutsche Bank also raises the possibility of some of the more hawkish elements of the ECB flagging concerns over monetary financing.