Steen Jakobsen
The Bank of Japan has abandoned quantitative easing and the European Central Bank may taper its bond-buying programme, so what is the role of central banks in 2017, asks Saxo Bank’s chief economist Steen Jakobsen.
Article / 30 May 2016 at 12:10 GMT

How the ECB plans to fly under markets' radar

Blogger / MoreLiver's Daily
  • 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
Mario Draghi
The ECB has raised the "new nothingness" to an art form. Photo: Wikimedia Commons

By Juhani Huopainen

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, 
below-target inflation rates were seen with oil above $100/barrel:
EZ inflation

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Source: 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? 

I don’t believe the comment was made accidentally. Perhaps it was a revelation of the governing council’s consensus view, which had to be brought forward to counter the German hardline rhetoric.

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. 

The last thing the ECB wants to do is to face criticism that the highly-indebted countries get preferential treatment from the central bank.

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:

Source: Saxo Bank

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. 

Better not slip, Mario.

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. 

This is understandable market behavior ahead of June’s big event list – markets become range-bound and overall trading activity decreases.

EURUSD hourly chart with the bear channel:
EURUSD hourly
Source: Saxo Trader

The longer-term range of roughly 1.15-1.05 still seems to hold, and we are now right in the middle of it. There is no technical confirmation of the pair turning higher, so for the moment the trend is our friend and while I would love to throw myself under the bus and anticipate a turnaround, it is a fool’s game until the technical picture changes.

EURUSD daily with the longer-term horizontal range 
in blue lines and the post-December rising channel:
EURUSD daily
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 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

Juhani Huopainen is a blogger and a macro analyst at More Liver’s Daily. Follow Juhani or post your comment below to engage with Saxo Bank's social trading platform.
30 May
zefy zefy
Thank you Juhani about these views before ECB Thursday. I am intrigued to see your comments on Thursday what actually happened after ECB announcement, reactions etc.
Generally, it would be good if TradingFloor would have before/after article beginning/end on those weeks where expected market moving / high impact event (ECB, FED, ...) takes place, just an idea.
30 May
Juhani Huopainen Juhani Huopainen
The FX 4 Next Week on Fridays by John J Hardy covers the next week's events, and for the really special events (for example ECB and Fed meetings) there usually are designated "before" and "after"-posts. Sometimes "after" is just a short note or squawk, sometimes a longer text.

I would be glad to hear what kind of previews/reviews you would like to see. As I've always said, "I do requests" :)
31 May
zefy zefy
I am building my own understanding how central bank events before/after affect my own trading models. Your articles very well cover different aspects of those events and expectations so at the moment I do not have specific preview/review requests. Thanks for asking, highly appreciated. I will let you know if there is something...
For TradingFloor site I was thinking if there could be a specific tag or title which would collect all special event articles/comments. At the moment I follow your and Steens comments which are very valuable, and I will check FX 4 next week too, thanks for hint.
31 May
zefy zefy
Very nice :)


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