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Analysis
Markets demand details from ECB

Markets demand details from ECB

Draghi prepares for new forward guidance in March

by Marchel Alexandrovich in London

Thu 25 Jan 2018

Speaking in Frankfurt last week, Benoît Cœuré, a member of the European Central Bank's executive board, stressed that the euro area economy is no longer just 'recovering, but is expanding'. Meaningful expansion may advance talks for an earlier-than-expected increase in euro area interest rates, though President Mario Draghi will want to avoid confusing markets. His comments after today's governing council meeting will probably focus on the next steps for quantitative easing rather than potential interest rate changes.

Eurostat, the European Union's statistical agency, will publish its estimate of euro area GDP growth for the fourth quarter of 2017 on 30 January. Given the robustness of domestic surveys and the positive flow of global macroeconomic data, it is increasingly probable that growth will surpass the ECB's forecasts in the coming year. Discussions at the ECB's governing council are moving from setting policy to nurture a recovery towards normalising policy in such a way as not to shock market expectations and avoid a sharp increase in borrowing costs.

With QE in the euro area approaching its end, whether the ECB stops its purchases entirely after September or tapers and extends them for a few extra months is no longer such an interesting question. Instead markets will focus on what the ECB considers to be an appropriate length of time between the end of QE and the first rise in its deposit rate since 2011. The rate has been held at minus 0.4% since March 2016. Klaas Knot, head of the Dutch central bank and a member of the ECB's governing council, a few months ago cited the example of the US Federal Reserve, where the first rate rise came a full year after the end of QE.

But if growth figures continue to surpass expectations, the ECB may adjust its course of action. There are those on the governing council who view negative interest rates, as well as QE, as an extraordinary policy measure which is no longer justified. They will argue strongly that returning the deposit rate to zero should quickly follow the end of QE.

Draghi will not want to unsettle markets by mixing his message on QE with any discussion of what may eventually happen to interest rates. But as the ECB prepares to change pace, the likelihood of communication missteps will grow substantially.

At today's meeting the governing council is likely to leave the language around its forward guidance unchanged. But Draghi will make it clear in his session with journalists that the ECB may revisit its forward guidance configuration on 8 March to reflect improved macroeconomic forecasts. One way for him to give a more balanced assessment of the ECB's mindset is to reiterate the weakness in core inflation in the euro area. This should help Draghi justify why the ECB is taking its time to amend its forward guidance.

The journalist session could also include questions on Draghi's views on the work of Philip Lane, governor of the Central Bank of Ireland, on 'European safe bonds', an idea which involves repackaging sovereign bonds from various European countries into a safe security. Draghi will probably respond that the ECB welcomes anything that increases the stability of economic and monetary union.

Discussions may likewise address the forthcoming ECB vice-presidency vacancy following the departure of Vítor Constâncio at the end of May this year. Luis De Guindos, Spain's economy minister, is rumoured to be on the shortlist, though Draghi is unlikely to comment until the candidate is formally approved. The appointment will be of great significance to markets. Constâncio, a consistent dove, has been effective at communicating the ECB's intentions during his tenure. His replacement will hopefully bring the same qualities as the ECB continues its transition towards policy normalisation.

Marchel Alexandrovich is Senior European Economist at Jefferies International.

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