ECB Monetary Policy Preview: QE Bond Purchases to Continue Beyond March 2017

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Image via European Central Bank

The European Central Bank’s meeting this Thursday is unlikely to prove to be a market mover as expectations are high that the central bank will be expanding its QE purchases.

The ECB’s governing council meets on Thursday, December 8 where the central bank is expected to announce its decision on whether it will expand its QE purchases and perhaps tweak the size of its bond purchases as well. The central bank could also be seen announcing whether it will change the eligibility criteria for its bond purchases.

The European central bank had initially set a date for the QE purchases to end by March 2017. This view brought forth expectations of the tapering announcement in the previous meetings, which was quickly brushed aside with the ECB noting that QE was not discussed. The markets had begun to price in the fact that ECB could begin winding down its QE purchases in light of a somewhat modest pickup in the euro area.

The hawkish view, however, changed after ECB President Mario Draghi, speaking over the past few weeks hinted that the central bank would maintain its pace of purchases and probably look at an extension beyond the initial deadline of March 2017. Officials maintained that QE remained a key part of the euro area recovery and highlighted the risks of a premature exit. Therefore, there is a strong consensus that the ECB will maintain a dovish rhetoric underlining its view that the central bank will continue with its QE purchases until there was a clear trend in underlying inflation.

Inflation has shown signs of a pickup, with oil prices also rising steadily and up from its $30 handle seen in February this year, but this has been brushed aside as officials who seek more conviction that inflation is starting to move higher.

Small but positive signs of economic recovery in the Eurozone

At the latest reading, Eurozone’s flash inflation estimates showed the headline CPI at 0.6% while the core CPI was seen at 0.8%. Although inflation remains well below the 2% target rate, officials are not convinced about the recent increase in inflation and its current trend.

Besides inflation, unemployment was also seen improving. Data released last week by the European statistics agency showed that unemployment rate was 9.8%, down from 9.9% in September, while the EU28 unemployment rate fell from 8.4% to 8.3% in October.

Euro area and EU28 Unemployment Rate, October 2016
Euro area and EU28 Unemployment Rate, October 2016

The unemployment rate was the lowest rate recorded in the EU28 since February of 2009, while the euro area unemployment rate at 9.8% was the lowest since July 2009.

QE to be extended to September 2017

Based on the above factors the markets are dealing with a certainty that the central bank’s bond purchases will continue through September 2017. However, some expect this to see more QE expansion next year. Analysts at Danske Bank note in this regard that with “Wage and core inflation will remain too low for the ECB to change its stance on monetary accommodation in mid-2017, implying a third QE extension is likely to be announced.”

The ECB will also be releasing its economic forecasts at its meeting this week. A poll of over 70 economists, published by Reuters last week showed that the economists expect GDP to grow 1.65% in 2016 before slowing to 1.4% in 2017 and rising to 1.5% in 2018. On inflation, the median estimates show that inflation will average at 0.2% this year but rise to 1.35% in 2017 and 1.5% in 2018.

Draghi had previously hinted that inflation is expected to rise to 2% by 2018-2019 period.

EURUSD recovered from the lows of 1.0504 on Monday after Italian voters rejected calls for constitutional changes. This eventually led to the Italian Prime Minister, Renzi resigning from his post. The single currency went on to close the day in the positive and with strong gains, rising to a 14-day high at 1.0759 by Monday’s close. Support is seen at 1.0600, to which the single currency may fall, but the overall trend remains to the upside. The unfilled gap at 1.0853 is very likely to be breached on a positive reaction to the ECB meeting.

EURUSD: Resistance established at 1.0765
EURUSD: Resistance established at 1.0765

Watch for a near-term decline to 1.0600 support level ahead of Thursday’s ECB meeting, following which the single currency should be expected to push higher, initially targeting 1.0765 resistance.

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