EUR/USD: Draghi may be less dovish this time
We do not expect any new policy announcement when the ECB meets on Thursday. However, following the recent strong improvement in economic data and the jump in inflation to 2%, the ECB is likely to:
1. Raise its GDP and CPI forecasts for this year, although the latter on the back of commodity prices, thus leaving the inflation trajectory hump-shaped with no change to the medium-term outlook;
2. Drop the easing bias on rates, and
3. Confirm the stance on asset purchases, including the commitment to buy more if the outlook worsens or financial conditions tighten excessively.
Looking more specifically at the new forecasts, while GDP growth in 4Q16 was fractionally below the ECB’s expectations, surveys suggest upside risks to the central bank’s growth expectation for the first quarter 2017 and possibly beyond. Coupled with some upward revisions to previous GDP data that strengthen the carryover entering 2017, this should allow the ECB to revise up its growth forecast for 2017 by 0.1-0.2pp to 1.8-1.9% and to acknowledge a further mitigation of downside risks. We expect the GDP number to remain at 1.6% for both 2018 and 2019, as higher energy prices compared to three months ago broadly offset improving prospects for global trade and a slightly weaker trade-weighted EUR.
On the inflation front, the latest data have clearly exceeded ECB expectations. However, this is due to energy prices and, to a lesser extent, unprocessed food prices, while core inflation remains at the bottom of the range consistent with the previous set of ECB projections.
Therefore, the ECB will revise up its headline CPI projection for this year, probably to 1.7-1.8% from 1.3%, while leaving unchanged the trajectory for the remaining part of the forecast horizon, given that the core CPI forecast is likely to be confirmed (at 1.1% in 2017, 1.4% in 2018 and 1.7% in 2019). This would imply a hump-shaped path for headline CPI, with a relatively strong reading in 2017 followed by a weaker 2018 and a renewed, more sustainable, acceleration towards prices stability over the final part of the forecast horizon thanks to a strengthening of core prices. We expect average headline CPI for 2019 to be confirmed at 1.7%. At GrowthAces.com we forecast steeper inflation path with accelerating inflation in 2018 and 2019.
Forecast revisions are likely to increase the central bank’s confidence that downside risks are slowly dissipating. This may convince the ECB to drop from its introductory statement the reference to the possibility of a further lowering of policy rates. The debate within the Governing Council on this topic is already in full swing, with hawk Yves Mersch and dove Philip Lane openly arguing for opposite strategies: the former wants to get rid of the easing bias for credibility reasons, the latter wants to retain it to avoid sending a premature tightening signal. Our view is that the hawks have better ammunitions at this meeting: moving to a neutral bias on rates seems consistent with the evolution of the macro outlook and of the risk assessment, and would probably have limited impact on financial conditions because the market is already assigning a very low probability to a further cut in the deposit rate.
We think that the ongoing upsurge of euro-area activity indicators and the pickup in headline inflation could cause ECB president Mario Draghi to sound slightly less dovish, supporting the EUR.
GrowthAces.com - Daily Forex Trading Strategies
We do not expect any new policy announcement when the ECB meets on Thursday. However, following the recent strong improvement in economic data and the jump in inflation to 2%, the ECB is likely to:
1. Raise its GDP and CPI forecasts for this year, although the latter on the back of commodity prices, thus leaving the inflation trajectory hump-shaped with no change to the medium-term outlook;
2. Drop the easing bias on rates, and
3. Confirm the stance on asset purchases, including the commitment to buy more if the outlook worsens or financial conditions tighten excessively.
Looking more specifically at the new forecasts, while GDP growth in 4Q16 was fractionally below the ECB’s expectations, surveys suggest upside risks to the central bank’s growth expectation for the first quarter 2017 and possibly beyond. Coupled with some upward revisions to previous GDP data that strengthen the carryover entering 2017, this should allow the ECB to revise up its growth forecast for 2017 by 0.1-0.2pp to 1.8-1.9% and to acknowledge a further mitigation of downside risks. We expect the GDP number to remain at 1.6% for both 2018 and 2019, as higher energy prices compared to three months ago broadly offset improving prospects for global trade and a slightly weaker trade-weighted EUR.
On the inflation front, the latest data have clearly exceeded ECB expectations. However, this is due to energy prices and, to a lesser extent, unprocessed food prices, while core inflation remains at the bottom of the range consistent with the previous set of ECB projections.
Therefore, the ECB will revise up its headline CPI projection for this year, probably to 1.7-1.8% from 1.3%, while leaving unchanged the trajectory for the remaining part of the forecast horizon, given that the core CPI forecast is likely to be confirmed (at 1.1% in 2017, 1.4% in 2018 and 1.7% in 2019). This would imply a hump-shaped path for headline CPI, with a relatively strong reading in 2017 followed by a weaker 2018 and a renewed, more sustainable, acceleration towards prices stability over the final part of the forecast horizon thanks to a strengthening of core prices. We expect average headline CPI for 2019 to be confirmed at 1.7%. At GrowthAces.com we forecast steeper inflation path with accelerating inflation in 2018 and 2019.
Forecast revisions are likely to increase the central bank’s confidence that downside risks are slowly dissipating. This may convince the ECB to drop from its introductory statement the reference to the possibility of a further lowering of policy rates. The debate within the Governing Council on this topic is already in full swing, with hawk Yves Mersch and dove Philip Lane openly arguing for opposite strategies: the former wants to get rid of the easing bias for credibility reasons, the latter wants to retain it to avoid sending a premature tightening signal. Our view is that the hawks have better ammunitions at this meeting: moving to a neutral bias on rates seems consistent with the evolution of the macro outlook and of the risk assessment, and would probably have limited impact on financial conditions because the market is already assigning a very low probability to a further cut in the deposit rate.
We think that the ongoing upsurge of euro-area activity indicators and the pickup in headline inflation could cause ECB president Mario Draghi to sound slightly less dovish, supporting the EUR.
GrowthAces.com - Daily Forex Trading Strategies