Once a year, the Governing Council of the ECB meets away from its base in Frankfurt. This year, the ‘away’ meeting takes place on 14 June in Riga, capital of Latvia, which is of course one of the three Baltic states (the others being Estonia and Lithuania). All three have adopted the euro.
Anyway, back to business – it’s likely this monetary policy meeting will bring more evidence of the ECB’s very gradual edging toward an unwinding of its asset purchase programmes (APPs).
In March, the ECB dropped its explicit commitment to expand its APPs should the eurozone expansion falter.
European Central Bank watchers had long concluded that a sustained increase in the pace of, or a significant extension in the duration of, the programme was not plausible. There are simply not enough eurozone sovereign bonds left for the ECB to buy.
The ECB’s inflation forecast for 2019 (see Exhibit 1 below) was also revised slightly downward (largely reflecting different assumptions about the path of oil prices) in March.
Exhibit 1: ECB staff macroeconomic projections, March 2018 (in %)
Note: (*) Eurostat actual data (YoY change), (**) Eurosystem staff macroeconomic projections. Source: ECB, BNP Paribas Asset Management, as of March 2018
Since then, the economic environment in the eurozone has weakened slightly. According to the account of the monetary policy meeting on 25-26 April, participants felt there was greater uncertainty on the growth outlook and that demand could very well weaken more than previously expected, as growth appears to be slowing in all countries and sectors.
Leading economic indicators (see Exhibit 2 below) are indeed pointing to a GDP growth rate well below the robust pace of 2017. The ECB nonetheless stressed that growth is still healthy and it would stick to its roadmap and halt its asset purchase programmes in the fourth quarter of 2018.
Exhibit 2: Eurozone GDP growth and PMI surveys
Source: Bloomberg Markit, BNP Paribas Asset Management, as of 12/06/2018
François Villeroy de Galhau, Governor of the Banque de France, summarised matters nicely: “the time when our net asset purchases will end is approaching – […] whether it will be in September or in December is not a deep existential question”.
The rebound in headline inflation, from 1.2% in April to 1.9% in May was helpful and core inflation ticked up to 1.1% (0.7% in April). As headline inflation was below 1.5% at the start of 2018, this development could be seen as confirmation that eurozone inflation has made a welcome return to the path towards the 2% target.
Exhibit 3: Changes in the pace of eurozone inflation (YoY, %) 1999-2018
Source: Bloomberg, BNP Paribas Asset Management, as of 12/06/2018
To some extent, Peter Praet, Executive Board member of the ECB, has given the game away regarding the outcome of this meeting in Riga: “Signals showing the convergence of inflation towards our aim have been improving, and both the underlying strength in the euro area economy and the fact that such strength is increasingly affecting wage formation supports our confidence that inflation will reach a level of below, but close to, 2% over the medium term.”
Some may ask: “What about Italy ?” The ECB already answered this question at the end of May, following the spike in Italian bond yields, by letting it be known through “various sources” that it saw no reason to intervene and as a central bank, it had neither the tools or mandate to solve what it considers to be essentially a political crisis.
It seems that the ECB’s decision to stop purchasing assets has been taken, but has yet to be announced. It is likely that Mario Draghi will employ all his know-how to avoid unnerving investors.
Should further reassurance be required, the ECB Forum on Central Banking in Sintra, Portugal on 18-20 June would provide an opportunity (this year’s forum is on ‘Price and wage-setting in advanced economies’).
This week’s meeting should mark another milestone on the long path towards interest-rate normalisation.
However, once President Draghi exits the stage on 31 October 2019, a new era will begin. His successor could have a fundamentally different interpretation of the mandate and the merits of different unconventional monetary tools.
Under these circumstances, it is very hard to know how fast the unconventional ECB policy measures will be wound up and how the raising of key policy rates will be managed.