PIMCO expects no policy changes at the ECB Governing Council meeting on Thursday, aside from a minor adjustment to the bank’s outlook for growth. We think ECB President Mario Draghi will repeat the message that although the economic recovery is gaining momentum, risks remain, and that the improving outlook for inflation continues to depend on prolonging the bank’s ultra-accommodative policy stance.
No policy change…yet
Three factors argue for no major policy changes just yet:
- First, geopolitical risks in the eurozone have not been eliminated, even if they diminished last Sunday following Emmanuel Macron’s victory in the first round of the French presidential elections;
- Second, inflation has yet to fulfil all four criteria outlined by Draghi as prerequisites before withdrawing stimulus; and
- Third, Draghi was obliged earlier this month to rein in expectations for a speedier exit triggered by some national central bank governors.
These factors point to leaving forward guidance broadly intact, specifically the wording that policy rates will stay “at present or lower” levels and that the risks surrounding the GDP growth outlook “remain tilted to the downside.”
Tapering in 2017 still likely
That said, Draghi has already started to hedge out these downside risks, stating in March that they have “become less pronounced”. Ongoing improvements in eurozone growth data and diminished geopolitical risk since then do indeed warrant bolder acknowledgement of the better macro environment sooner or later. The ECB otherwise risks entrenching unduly depressed expectations about growth and inflation.
In terms of what this means for policy, our baseline forecast is that the ECB will end quantitative easing (QE) by June 2018, with the following sequence of actions:
- Change forward guidance to reflect a more symmetric policy stance at the 8 June 2017 meeting;
- Taper asset purchases at the 7 September 2017 meeting, effective in January 2018, ending QE by the end of June 2018;
- Begin normalizing the Deposit Facility rate in the first half of 2019; and
- Reinvest proceeds from maturing assets throughout this period, allowing its balance sheet to passively run down from 2020 onward.
Wages are not responding to lower unemployment, even in strong countries that have little spare capacity in their labour markets, making achieving the ECB’s close-to-2% inflation target simply by purchasing financial assets challenging. While QE has significantly supported aggregate demand, it is not costless, neither in terms of financial stability nor equity. The longer QE drags on, the more these costs rise.
