July ECB Monetary Policy Preview – A balancing act for Draghi

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The European Central Bank’s meeting this week will most likely be a non-event as far changes to monetary policy is concerned. This includes the QE purchases staying unchanged at 60 billion euro per month while the key deposit and lending rates will remain steady.

However, the fireworks could most likely come during the press conference when the ECB chief will be brief reporters. At the heart of the meeting will be the question as to what the central bank will signal in terms of forward guidance.

Any hints of hawkish comments could no doubt keep the euro maintain its bullish gains. Therefore, Draghi will most likely need to double down on dovishness and strike a similar chord as he did in March when the ECB chief managed to talk down the euro while at the same time he announced a 20 billion euro cut to the QE purchases.

Draghi’s hawkish comments in Portugal

On June 27, the ECB chief gave a speech at a banking conference in Sintra, Portugal. Bond yields fell sharply after his comments that the central bank was on track to shrinking its monthly asset purchase program.

At the event, the ECB chief said, “monetary policy is working to build up reflationary pressures, but this process is being slowed by a combination of external price shocks, more slack in the labour market and a changing relationship between slack and inflation. The past period of low inflation is also perpetuating these dynamics.”

The comments saw investors to understand that the central bank would begin to cut back on its QE purchases and look towards a tightening case for monetary policy in the longer term.

The case in point was the surge in the 10-year German bund yields. Just over a year ago, yields were around -0.09%, compared to the current levels of 0.50%.

ECB’s June Meeting Minutes

The case for hawkish forward guidance was also partly attributed to the June meeting minutes. The report showed that the ECB’s governing council had discussed although vaguely about the need to scale back its asset purchases.

The June meeting minutes showed that “While there were valid reasons at this juncture to retain the APP [asset purchases program] easing bias, it was noted that, as the economic expansion proceeded and if confidence in the inflation outlook improved further, the case for retaining this bias could be reviewed.”

Rumors of ECB QE Tapering in September

As is common with the ECB, last week a media report showed that the ECB could hint at this week’s meeting about a potential tapering when it meets in September. The euro currency was a bit volatile last Thursday.

Initially, ECB’s governing council member, Ilmars Rimsevics said that the central bank will stick with QE for a few more years as the central bank was unlikely to meet its medium term inflation target of 2%.

While the euro initially fell on the dovish remarks, the media report suggesting the announcement of QE tapering this week saw the common currency trim losses.

The EURUSD has been consolidating for a while near the $1.1400 handle. The gains come on account of a mix of hawkish ECB signals and a dovish Fed. But, so far it is purely speculation.

We do not know for sure if the ECB will indeed tighten its bond purchases and even if it does, the ECB Chief Draghi is known to be a master of words and could easily talk down the euro. Amid the above uncertainty, the fact remains the euro could be in for some volatile moves this week.

Will Draghi go with the markets and come out hawkish and in support of tightening QE or will he be able to trick the markets into announcing QE tapering while pushing the euro lower at the same time?

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