The ECB’s Dashboard: Taper auto pilot

When does a central banker know that he has done an excellent job? When QE can be brought to an end and hardly anyone seems to care. This definition characterises the ECB’s recent and next steps.

As market volatility on the back of trade tensions, Turkey and Italian fiscal policies has not left any significant marks on the Eurozone economy, the ECB will in our view announce the next step of its dovish tapering on Thursday: a reduction of the monthly QE purchases to EUR15bn from EUR30bn currently.

We don’t expect the latest round of ECB staff projections to deliver any new insights on growth and inflation. Our main focus will be on the ECB’s forecast for core inflation, which up to now has been subject to extreme optimism but has shown very little progress.

With a reduction of the QE purchases, the ECB remains on auto pilot towards an end of QE by year-end. Therefore, there is very little reason to change the communication or forward guidance.

EUR/USD should be largely unaffected by this week’s ECB meeting as (a) the taper autopilot has been clearly and fully communicated (thus no surprise there vs market expectations); (b) the firm forward rate guidance on the ECB deposit rate makes any potential ECB interest rate re-pricing a story for 2019 rather than this year. As a result, the ECB is unlikely to provide a catalyst for meaningful EUR moves this week.

Rather than relative monetary policy outlook (on the USD side, the Fed outlook for 2018 is fairly priced), the main driver behind the EUR/USD price action remains the general risk environment and the spectre of trade wars. At this point (and despite the Eurozone current account surplus) this is a negative for EUR/USD given the pro-cyclicality of the EUR/USD (see chart below), the openness of the Eurozone (EZ) economy (vs the relatively closed US economy) as well as the threat of EZ specific tariffs coming from the US administration.

The reduction in net QE purchases has been well telegraphed and should not surprise anyone. If anything, some faint hopes that Draghi could adjust the anticipated path to the risk environment, which would need to be priced out. In that regard trade, EM concerns and the Italian budget and should remain the main drivers for rates this coming week.