Global Daily – Why is the ECB sticking to its optimistic outlook?

by: Nick Kounis , Bill Diviney

ECB view: Mr Draghi’s optimistic take may reflect the wish to end net purchases – ECB President Mario Draghi spoke today before the House of Representatives in Ireland. As with his comments following the last ECB Press Conference, the tone on the economic outlook remained rather positive. Mr Draghi asserted that ‘while some sector-specific data and selected survey results have been somewhat weaker than expected, the latest incoming information overall suggests that the broad-based expansion in the euro area… is set to continue. Against this background, euro area inflation is expected to continue to converge towards the ECB’s objective of below, but close to, 2% over the medium term’. In addition, despite listing only downside risks (protectionism, vulnerabilities in emerging markets and financial market volatility remain/are prominent), he remained of the view that ‘the risks surrounding the euro area growth outlook can still be assessed as broadly balanced’.

Given weaker data and growing downside risks, why is the ECB sticking to its optimistic outlook?  One explanation is that some of the factors dragging down economic growth in Q3 might be transient, so the central bank wants to get a clearer picture of the underlying trend. Perhaps more importantly, the ECB wants to end asset purchases and it does not want to give investors reasons to think it may not do so. Indeed, the guidance on ending asset purchases is data dependent, so it may not want to give the impression that the economic outlook has deteriorated at this stage.

We continue to think that the ECB will downgrade its economic outlook in the coming months and will therefore change its tone. However, this has implications for the other tools at its disposal rather than net asset purchases. Indeed, the ECB President continued to signal that ‘significant monetary stimulus will still be needed’ and that ‘even after we end our net asset purchases, monetary stimulus will continue to be provided by the guidance we have given namely that we expect to keep interest rates at their present levels at least through the summer of 2019 and to maintain the stock of assets on our balance sheet by reinvesting maturing bonds purchased under the asset purchase programme for an extended period of time after the end of our net asset purchases’.

So the ECB is focusing on the forward guidance on interest rates and reinvestments to provide continued stimulus. Indeed, we found it noteworthy that Mr Draghi asserted that the ECB’s forward guidance can change if the economic outlook worsens. Indeed, a downgrade of the ECB’s growth forecasts over coming months could well trigger the ECB to signal that the period of unchanged rates and reinvestments will last even longer. (Nick Kounis)

Fed View: The last FOMC meeting without a press conference – Today’s FOMC statement is likely to be received in a muted fashion markets, with probably only minimal changes. The statement has been considerably shortened since Jerome Powell took over as Chair, and not a great deal has happened on the macro front to change the assessment of the outlook. Today’s meeting will also be the last FOMC meeting without a press conference to accompany it. From next January, Chair Powell will hold a press conference after every FOMC meeting, not just on the quarterly projections meetings. The timing of the move to increased transparency could prove to be pertinent, as for the first time in years the Fed is likely to be signalling a shift in its policy path in 2019. Our base case is that the June 2019 rate hike will be the last one in this cycle. As we approach that time, the FOMC will want to signal – both through its ‘dots’ rate projections and through public commentary – that we are approaching the end of the rate hike cycle. A higher frequency of press conferences should give Chair Powell ample opportunity to gradually prepare the market for such a shift. (Bill Diviney)