ECB Preview : Confirmation of a dovish tilt?

ECB Preview : Confirmation of a dovish tilt?

Macro
CD
Christopher Dembik

Head of Macroeconomic Research

Summary:  This week's ECB meeting was set to be a non-event. It was without counting on the release of the central bank's strategy review on 7 July. We expect the new policy framework will make the Governing Council more committed to its dovish stance, at least in the short term. But investors might struggle to see major adjustments to the ECB's forward guidance this week. In our view, the upcoming meeting will mostly be a repeat of the previous one with slight adjustments to the ECB's wording and outlook. Behind the scenes, we believe that the divisions between the doves and the hawks about the future of the bond purchase remain intact.


Overall, ECB Christine Lagarde is likely to lean dovish. Investors might be disappointed if they expect major adjustments to the ECB’s forward guidance. Given the rapidly changing economic outlook due to the spread of the Delta variant, which is now the dominant strain in most member countries, and the risk of upside inflation surprise, there is a material risk that the ECB will delay any policy announcements until it has more data available after the summer season. If circumstances make it necessary, the new policy framework can give the Governing Council more latitude to act fast when it will meet again on 9 September.

What NOT to expect ?

  • There is little change to expect on forward guidance on rates. It is perhaps too early for the ECB to commit to lower for longer rates unless there is a significant change in the macroeconomic outlook. This is not the case.
  • The ECB should refrain from emphasizing the role of the euro exchange rate in inflation developments and/or from looking actively to push down the euro. The euro/dollar exchange rate is currently far from pain threshold for the eurozone economy, for instance.
  • Any change to the Targeted Longer-Term Refinancing Operations (either an extension or/and an easing of conditions) are off the table for the moment.

What to expect ?

  • The ECB should provide greater clarity in the wording of its forward guidance, and especially of its definition of the end of the Covid-19 crisis.
  • The ECB should maintain a cautiously optimistic outlook for the economic recovery in the eurozone, with the acknowledgement of downside risks posed by the spread of the Delta variant. Our baseline is unchanged: growth and inflation will likely surprise the ECB to the upside in late 2021 and in 2022, as it has done so far this year.
  • The ECB could potentially draw a more explicit link between the Asset Purchase Programme (APP), which is expected to run until shortly before the first hike, and the new inflation target set at “2%”. The first hike is pencilled in for the end of 2022-early 2023 by most forecasters. This would be interpretated by the market as a clear dovish tilt towards prolonged accommodative monetary support.
  • The ECB should confirm once more that the unconventional monetary measures are becoming conventional and are fully part of the standard framework. This has attracted little attention from investors when the ECB released its strategy review on 7 July. It is, however, of crucial importance as it means the ECB can make more rapid deployment of previously unconventional monetary policy tools if the economic or inflation outlooks require it.

How far the ECB is able to go ? Behind the scenes, we expect a very heated debate between the doves and the hawks about the future of the bond purchases, as it was the case for the ECB June meeting . Recently, Lagarde hinted the existing Pandemic Emergency Purchase Programme (PEPP) would be followed by a “transition into a new format”. We think there is a broad agreement the PEPP will run until March 2022. But it is unclear how much support Lagarde will be able to gather to replace the PEPP by a new program whose format, duration and objective have yet to be clearly defined. It is certainly not until early 2022 that we will have more indications of what the ECB is ready to do and can do taking into consideration the hawkish minority of its governing council. The two other factors which will play a key role in the future of the bond purchases are the outcome of the German federal elections of 26 September and how fast the eurozone will get back to its pre-crisis level – at the moment, it should happen in early 2022.

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