How the ECB plans to fly under markets' radar
- The ECB will do its utmost to sound moderately optimistic, vigilant
- Bank must ease QE constraints at its September meeting
- Containing the populists, angry Germans is paramount
- ECB's Liikanen hinted at allowing above-2% inflation for a while
The European Central Bank’s governing council will announce possible policy changes on Thursday, June 2 at 1145 GMT. Following the announcement, at 1230 GMT ECB president Mario Draghi will begin a one-hour press conference (live video link) by reading a statement.
ECB to stand pat…
The meeting is widely expected not to produce anything concrete. Earlier, several research desks believed that the June meeting would review the effects of the measures launched at the March 10 meeting, note the slow progress, provide a small rate cut, and promise to return with appropriate policy shifts later in the year.
...putting its hope on higher oil prices
Now the consensus view has shifted. The Brent crude oil price has risen from last January’s low of 27.10 to a recent high of 49.85. The ECB will publish updated macroeconomic projections, and the previous 2018 inflation forecast of 1.6% will likely be increased to 1.8%.
While oil prices and inflation rate move hand-in-hand,
Create your own charts with SaxoTraderGO click here to learn moreSource: Saxo Bank
This is a bit weird, as the five-year, five-year forward start inflation swap shows inflation expectations have not responded to higher oil prices – they are at 1.5%, only marginally above the all-time lows seen during the late 2015 and early 2016.
ECB to allow inflation above 2%?
In a curious side event, the ECB’s Finnish member Erkki Liikanen said in an interview that unless the ECB allows inflation to occasionally run over the 2% level, it will never be able to reach that target. He said the ECB “must be consistent in both ways” and that his approach is “symmetric in both directions”.
Was this a trial balloon of a possible new official policy? Or subtle signaling that markets should not be overly worried about the higher price of oil and the ECB’s possible hawkish turn further down the road?
QE-limits approaching, changes to come in September
The ECB’s bond purchase programme will begin hitting the issuer and issue limits toward the end of 2016 or latest in early 2017. This means the ECB must address those limits at its September meeting, and a relaxation of the existing limits (allowing more purchases of German bonds) is much more probable than changing the composition of the programme.
Avoiding Germans, populists and the British
For now, the ECB wants to give some breathing space to Germans, who are angry at the bank’s easy monetary policy. Dovish talk now would probably be met with German counter-rhetoric, which would undermine the ECB’s credibility as the disagreements would again be discussed in public.
The ECB's balance sheet expansion is a risk to Germany:
At the same time, the ECB does not want to give free lunches to the Southern Europe’s populists. Easy central bank money equals easy running of fiscal deficits. On the other hand, signaling of tighter times would also aggravate the populists.
Britain’s Brexit referendum is also having an effect. Overly easy policy makes "Europe" sound like "irresponsible debt mutualisation". Too-tight policy, conversely makes it sound like "austerity-driven and deflation-targeting slump".
Sometimes communicating even a simple “we decided to do nothing” can make for a long walk on a tightrope. One wrong word from ECB’s president Mario Draghi, and it will near-instantly be in all the headlines of Spanish and British papers.
EURUSD’s recent downtrend shows no signs of ending
The EURUSD’s fall in May from a high of 1.1615 to a low of 1.1097 has been well-behaved, as a clear downward-sloping trend channel has contained the price action. During the past couple of days the downward momentum has possibly been waning a little bit, as the recent new low was shallower than the previous ones have been.
EURUSD hourly chart with the bear channel:
EURUSD daily with the longer-term horizontal range
Source: Saxo Trader
I’d guess the EURUSD will trade slowly lower with 1.1170 to 1.1000 being the probable range all the way until the Federal Reserve’s meeting on June 16. The key is not to break the 1.12 resistance area.
More recent TradingFloor.com articles by Juhani Huopainen
Review of March meeting: New-leaf ECB exceeds expectations, upsets investors
Preview of April meeting: ECB must meet German criticism of monetary policy head on
— Edited by Michael McKenna