ECB Sept Monetary Policy Meeting Preview

GUIDANCE AND FORECASTS TO DOMINATE

The European Central Bank (ECB) is expected to keep the rate on its marginal lending facility at 1%, its main refinancing operations rate at 0.5%, and its deposit facility rate at 0% at its September policy meeting. The market will, therefore, be looking to the ECB staffs’ updated economic projections, as well as the post-meeting press conference with president Mario Draghi.

The ECB meets against the background of an improving Eurozone economy. This week, the second reading of Eurozone GDP for the second quarter confirmed that the bloc had grown by 0.3%, emerging from six consecutive quarters of negative growth. Further, recent data shows that the rise in unemployment is easing, and the labour market seems to be stabilising.

Economic progress is also highlighted by recent business surveys. The flash composite measure of PMI rose to a 26-month high in August, with manufacturing PMI also at a 26-month high, retail PMI at a 28-month high, and services PMI at a 24-month high.

Dr Christian Schulz, an economist at Berenberg Bank, is confident that the Eurozone’s growth is gaining momentum: “The economic recovery is picking up speed, inflation remains low and there are no signs of credit-fuelled bubbles.” Accordingly, the ECB is unlikely to heavily discuss slashing rates further, he argues.

The markets’ focus will, therefore, fall onto ECB president Mario Draghi’s post-meeting press conference. Despite the improving economy, Mansoor Mohi-uddin, an FX strategist at UBS, expects Draghi to strike a cautious tone, stressing that rates will remain low for some time.

Mohi-uddin argues that Draghi’s caution will be based on Fed taper concerns, which have caused upward pressure in global rates: “The ECB's base case that the Eurozone will experience a modest recovery in the second half of this year is based on expanding exports.”

“By stressing that interest rates will remain at current levels or lower,” Mohi-uddin says, “Draghi will be aiming to stop the euro rising in value.” Accordingly, Mohi-uddin foresees very little upside risk in euro-dollar above 1.34, unless US data deteriorates significantly

Schulz, however, suggests that Draghi may begin to adopt a less dovish tone: “Downside risks have not disappeared, but are diminished. If the recovery progresses as we expect, the ECB may drop the reference to lower rates with its next round of forecasts in December at the latest.”

ECB VERSUS THE MARKET

Forward guidance is in vogue at global central banks, largely influenced by the US Federal Reserve’s effort to link monetary policy to economic thresholds. However, the ECB – like the Bank of England – still seems to be having trouble convincing the markets of its intentions.

Elwin de Groot of Rabobank points out that implied forward rates for Eonia and Euribor have been trending higher since July (when the ECB launched its forward guidance), and declares that “overall, the ECB has booked relatively little success with its forward guidance strategy.”

Draghi described these rises as “unwarranted” at his press conference in August, suggesting that there was still scope to lower all rates if required.

In a note, Laurence Boone, European economist at Bank of America Merrill Lynch, writes “given the lack of concrete policy action, we may well see a similar pattern to UK rates, where markets rallied into Carney’s speech and sold off afterwards. This poses a risk to our underlying steepening view for euro rates.”

To combat a steepening of rates in the Eurozone, Boone says that the ECB has the option of introducing another 6 month to 24 month long-term refinancing operation (LTRO) in conjunction with a 25 basis point cut in the refi rate, which “would help anchor low rates expectations in the short and medium term, and correct the upward drift in the Eonia curve,” although this is not BAML’s central scenario.

But Schulz posits that “a rate cut, or other stimulus options such as more long-term liquidity injections, may still be discussed at the meeting, but unless financial tensions intensify again, the ECB is unlikely to take any further easing action.”

Carsten Brzeski, an economist at ING, however, does not believe that there is any urgency for the ECB to amend its position on guidance: “Obviously, the ECB’s interpretation of forward guidance is a compromise between trying to lock in market rates and sustaining the ECB’s principle of ‘we never pre-commit’”

“This makes the ECB’s forward guidance a walk on egg shells,” believes Brzeski, “hoping that markets do not test the ECB’s determination. Not this week, but eventually, the ECB could be pushed as far as its central bank peers around the world.

UPDATED STAFF ECONOMIC PROJECTION

Traders will also be keeping their eyes on the latest quarterly economic forecasts from ECB staff, which will be published with the rate decision.

John Zhu, an economist at HSBC is only expecting only small changes to the projections, given the positive economic data. But Zhu notes that “it should at least be the first time that the ECB has not had to lower its 2013 growth forecast.”

HSBC analysts write that the European Commission’s decision to allow some Eurozone countries, like France and Spain, for example, more time to hit its fiscal budget targets “means that fiscal assumptions should be a little less tight”.

HSBC cautions, however, that the global macroeconomic environment – where rates are rising, energy prices like oil are higher, and the exchange rate assumptions are stronger – will be a challenge to Eurozone economic growth prospects.

As well as growth projections, the ECB’s staff will also update their view on inflation. Berneberg’s Schulz postulates that modest revisions to growth assumptions are unlikely to affect inflation projections. “This means that inflation will be forecast to stay below the 3% target at least until the end of 2014,” Schulz predicts.

RECENT ECB POLICYMAKER COMMENTS

ON RATES

29-Aug-2013, ECB’s NOWOTNY:

- Nowotny says such low interest rates something special historically

27-Aug-2013, ECB'S ASMUSSEN

- Asmussen says we expect our interest rates to remain at current levels or lower for an extended period of time

27-Aug-2013, ECB'S COEURE

- Coeure says rates will remain low for an extended period of time

23-Aug-2013, ECB’s NOWOTNY:

- Nowotny says does not see many arguments now for a rate cut

11-Jul-2013, ECB's Weidmann

- Weidmann: low interest rate policy is justified by subdued inflation outlook, weak economic conditions

- But low rates have side effects; must keep eye on reform drive, financial stability risks

ON FORWARD GUIDANCE

30-Aug-2013, ECB’s Nowotny:

- Nowotny says forward guidance means markets should not expect rate rise for some time

- Nowotny says central issue is inflation expectations, which are stable

- Nowotny says emerging market turmoil having no impact so far on euro zone economy

29-Aug-2013, ECB’s Nowotny:

- Nowotny says central banks' forward guidance plays role given very low growth rates, high uncertainty

- Nowotny says central banks have shown can react reasonably if needed

- Nowotny says central banks' forward guidance assures markets of low interest rates for foreseeable future

11-Jul-2013, ECB's Weidmann

- Weidmann: ECB forward guidance is not a change of strategy, just an effort to make monetary policy stance easier to understand

- Weidmann: ECB has not tied itself to the mast with forward guidance, which does not rule out rate hikes when inflation pressures emerge

ON OMT

02-Sep-2013, ECB’S COEURE

- Coeure says ECB OMT bond-buying programme is "not just words", ECB fully prepared to use them

26-Aug-2013, ECB's Weidmann:

- Weidmann says ECB govt bond purchases would weaken countries' own responsibility to solve problems

- Weidmann says the best way for ECB to contribute to crisis solution is by preserving price stability

ON ECONOMIC CONDITIONS

20-Jul-2013, ECB’s Weidmann

- Weidmann says time for Europe's exit from expansive monetary policy not yet come

- Weidmann says expects strong German economic growth in q2, easing in q3 to moderate expansion

- Weidmann: fed's announcement on possible end of expansive policy does not mean putting on breaks but taking foot off accelerator

- Weidmann: exit from expansive monetary policy linked with risks of international impact

07-Jul-2013, ECB's Weidmann

- Weidmann says monetary policy can't solve euro zone crisis, is consensus of governing council

- Eurozone needs structural reforms, end of implicit guarantees for banks and sovereigns - Weidmann

ON BANKS

04-Sep-2013, ECB'S ASMUSSEN

- Asmussen says timetable for single bank supervision is ambitious, but doable

- Asmussen: ECB, as supervisor, should decide alone which banks are no longer viable

29-Aug-2013, ECB’s Nowotny:

- Nowotny says seeing trend for market participants to hold more liquidity

- Nowotny says this trend could last some time

- Nowotny says deposits at ECB show enormous sums, reflect uncertainty but money markets starting to work

- Nowotny says such low interest rates something special historically

29-Aug-2013, ECB’S MERSCH

- Mersch says might be challenging to start bank supervision in planned time frame

- Mersch says will not start bank balance sheet assessment without backstop in place

26-Aug-2013, ECB's Weidmann:

- Weidmann: banks' govt bond holdings should be capped, backed by sufficient capital similar to corporate bonds

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