“Wings of a Dove”
1. Rates are not going any lower
Finally, finally, the ECB removed their reference to lower rates in the opening statement. The omission of two small words – “or lower” – from the second line of the press release is a change in the ECB’s forward guidance. Although this action had been much discussed and debated by the market, the Bloomberg consensus was surprisingly split – 48% were expecting the removal whilst 52% weren’t. We have seen some comments that this is an effective tightening of monetary policy, but we think that’s probably going too far. It’s really just acknowledging that the Euro-area growth picture has improved, and indeed ECB President Mario Draghi said just that in his opening remarks during the press conference – risks to growth are now “broadly balanced”.
2. Growth Forecasts Revised slightly Higher
ECB staff forecasts for Euro-area GDP were revised slightly higher, by 0.1% in 2017, 2018 and 2019 to 1.8%, 1.7% and 1.6%. In our opinion, these forecasts look to be on the low side. Even today, Q1 2017 Euro-area GDP was revised higher from 0.5% qoq to 0.6% qoq. This level of growth roughly translates into annual growth levels of 2.3%-2.5%, and ties in with the levels of Purchasing Managers Indices seen in recent months. In fairness, Draghi did note that incoming data confirm the stronger economic momentum, that survey results signal “solid, broad-based growth” and that the global recovery supports exports. But yet again, in a thinly-disguised swipe at European politicians, Draghi pointed out that Euro-area growth is being dampened by sluggish reform pace. The recent election of Emmanuel Macron as French President and likely re-election of Angela Merkel as German Chancellor in September may speed up some reforms, but overall we think the ECB will be forced to revise these growth forecasts higher.
3. Big surprise in Inflation Forecasts
This was, in our opinion, the big news from today’s meeting. The new staff forecasts for Euro-area headline inflation were revised lower, especially for 2018. The 2017 forecast was revised from 1.7% to 1.5%, the 2018 forecast from 1.6% to 1.3% and the 2019 forecast from 1.7% to 1.6%. So even in two years time, the ECB staff forecasts do not see inflation hitting their 2% target. Draghi tried to paint a positive picture on inflation in the press conference – the labour market is tightening, the output gap is closing, and the tail risks to inflation have disappeared. The inflation revisions are mainly due to energy prices, according to Draghi, but the lack of core inflation is mostly due to subdued wages, which are being dampened by structural changes. The ECB need to be patient on inflation, Draghi said, but despite some leaks about a lowering of inflation forecasts prior to the meeting, the extent of the forecast revisions were surprising.
4. No Discussion on Tapering
In response to questions during the press conference, Draghi noted that there had been no vote on policy normalisation, and whilst there hadn’t even been much discussion on the topic, two governing council members did make “observations” on normalisation. Draghi was at pains to point out that Quantitative Easing (QE) is running smoothly, and that the programme is flexible enough for the ECB’s needs. All of the ECB’s forecasts are predicated on a “substantial degree of monetary policy support”, which suggests that the ECB are in no rush to reduce asset purchases. But that leaves the ECB with a problem, because soon they will reach their self-imposed capacity limits for bond purchases in certain countries, most notably Germany. The market will need some resolution on this issue shortly – either the 33% limit gets removed or QE purchases deviate from the capital key process.
5. Overall – Dovish
Draghi suggested on numerous occasions that despite the removal of the phrase “or lower” from the official statement, rates could still be reduced if conditions warranted. But Draghi never took the opportunity to point out that tapering could occur faster if ECB growth forecasts were revised higher. If normalisation wasn’t discussed today, it suggests it only comes on the agenda for the September meeting. There is a growing risk that tapering is slower and takes longer than the market currently expects.