The ECB's balancing act toward tapering
The ECB is slowly preparing markets for the eventual tapering. We continue to expect the ECB to announce a slower pace of asset purchases in September, with tapering to begin in January 2018.
Eurozone growth was encouragingly strong in H1 2017, and the outlook remains favorable. At the same time, inflation is still subdued and appears unlikely to rise more meaningfully in the coming months. The European Central Bank (ECB) thus faces the difficult task of preparing markets for the eventual tapering of monthly asset purchases while signaling that the process will be carefully managed and data dependent.
How delicate the ECB's balancing act is was evidenced by the market reaction to a speech by ECB President Mario Draghi on 27 June. He merely stated that continuously strong economic data would warrant some adjustments of the policy parameters to keep monetary policy broadly unchanged. Nevertheless, markets reacted rather strongly, with Eurozone sovereign bonds yields rising significantly and EUR/USD jumping from below 1.12 to 1.135 on the day of the speech.
ECB setting stage for September announcement of 2018 tapering
In the coming weeks and months, the ECB will continue down its long path of policy normalization. In a first minor step, it is likely to make some changes to its policy statement at the 20 July meeting, possibly dropping its easing bias with respect to the asset purchase program ("We stand ready to increase our asset purchase program in terms of size and/or duration"). Removing this sentence would prepare the ground for the next important step – stating that asset purchases will be tapered from January 2018.
We think that the 7 September meeting will likely be used to announce this change. This date is favorable in that new ECB macroeconomic forecasts will be available by then. How large this initial tapering step will be and how long it will be applied for will largely depend on incoming economic data, but we think it will likely bring monthly purchases down by EUR 15–20 billion and should take at least a quarter.
Pace of tapering data dependent, no rate rise until late 2018 at earliest
How fast the ECB will proceed from there will also depend on the data. We consider it likely that the asset purchase program will be wound down within six to nine months. This also implies that, in 2018, the ECB may implement changes in the monthly pace of purchases more quickly after an announcement, i.e. possibly adjusting purchases already the following month. Reductions in quarterly increments of EUR 15–20 billion appear sensible here as well. The ECB will certainly emphasize the data dependent nature of tapering, and we think the program provides sufficient flexibility for delays in case of unexpected data weakness.
As for policy rates, we expect the ECB to leave them unchanged as long as it purchases assets, in line with its forward guidance and recent speeches of ECB officials. A small adjustment of the deposit rate could thus follow in late 2018 at the earliest. Increases in the main refinancing rate are only likely in 2019.