ECB Facing Growing Pressure to Clarify Its Intentions
Investors seem convinced that euro-zone rates will remain lower for longer than is realistic – which is why the ECB knows it must gradually shift expectations. At its 25 January meeting, we expect the bank to modify its forward guidance in an additional step towards normalization of its monetary policy.
For the first European Central Bank governing council meeting of 2018, many investors are expecting a change in the ECB’s forward guidance and a potential announcement about the end of its securities-purchase programme.
Over the past few weeks, some eminent ECB members – particularly Bundesbank President Jens Weidmann and board member Benoît Cœuré – have been pressuring the council to make a clear announcement about the end of the ECB’s purchase programme. They are joined by an increasing number of governing council members, who – according to the minutes of the latest meeting – favour a change in communication methods starting this year.
This last point is an important one, given its potential to influence the deep-rooted conviction among many investors that rates are set to remain lower for longer.
Until now, the ECB has justified its desire to maintain its securities-purchase programme by citing the fact that the inflation outlook remains below the bank’s medium-term target rate. Indeed, despite broad-based, steady and sustainable economic growth throughout the euro zone, the inflation outlook does appear to remain below the 2 per cent target. The issue is that against this backdrop, ECB comments that maintain a strong link between inflation and further QE simply strengthen the anchoring of long term rates at historically low levels, which could ultimately jeopardize financial stability.
As a result, at its 25 January meeting, the ECB will probably reiterate its planned sequence of monetary-policy normalization: discontinuing quantitative easing in a first step, followed by an increase in key rates at a later date.
For our part, we believe that rates are unlikely to be raised before 2019. The extreme sensitivity of the fixed-income markets to monetary-policy normalization was recently illustrated by the surge in US long-term yields and the ensuing market turbulence after the Bank of Japan announced plans to slightly reduce its bond purchases. Markets must clearly be prepared for hikes very gradually – which leads us to expect that the ECB will slowly clarify its communication policy over the first quarter.
In a broader context, the prospect of further divergence between European and US monetary policies during 2018 is growing increasingly clear. While the ECB is likely to leave its rates unchanged until 2019, we are expecting the Federal Reserve to raise rates three or four times this year. This would be a surprise to the markets, which currently anticipate only two hikes.
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The Fed isn’t expected to make major news during its 30-31 January meeting, but Franck Dixmier says this is still an interesting moment. Investors have finally priced in almost three rate hikes in 2018, and we will begin to learn where incoming Fed Chairman Jerome Powell stands on abandoning inflation targeting.