The ECB is some way off its inflation goal. That could spell good news for households, says Alan McQuaid.
Comments from ECB officials last week suggest that they are in no hurry to rush for the exit doors as regards cutting back on their monetary stimulus.
Its main priority is to ensure that eurozone inflation gets up to the official target of just under 2% but it remains some way off at the moment, and indeed hit a 14-month low of 1.2% in February.
The central bank is also worried about the euro rising too fast, as a 10% rise in the single currency would knock half a percentage point off inflation over the next 12 months.
It is hard to see any chance of an interest-rate increase until inflation is a lot closer to its target but that is unlikely anytime soon.
One of the most important communication challenges the ECB will face this year is to rotate its forward-guidance from focusing on its bond-buying, quantitative easing (QE) programme, toward focusing on interest rates.
This is a delicate task that is likely to bias the ECB toward wanting to announce plans to end or taper QE at its June 14 meeting before adopting new language on rate forward-guidance at its September 13 meeting.
ECB executive board member and “markets guru” Benoit Coeure in a speech last month delivered the intellectual basis for believing that an end to monthly purchases will have a limited impact, while low bond yields can be safeguarded due to the stock effect of QE.
However, his colleague on the executive board and the central bank’s chief economist Peter Praet seems less convinced and last week highlighted the importance of monitoring the reaction of the yield curve to the end of net asset purchases.
It seems likely that the more cautious view will dominate, suggesting the central bank will likely favour a two-step process of revealing QE plans, and once market reaction is gauged, deliver new forward-guidance on rates.
However, last Friday, the bond yields of many eurozone governments after Mr Praet warned that inflation in the bloc remained sluggish, a potential hurdle to the withdrawal of monetary stimulus.
The eurozone may have more unexploited capacity which could mean that inflation might take longer to rise back to the 2% target, Mr Praet said in an interview with Reuters.
There is a belief that the ECB will be able to end or taper QE without a repeat of the US Federal Reserve’s taper tantrum a few years ago, but a cautious approach will still be adopted.
For Mr Praet, it is optimal to adjust policy more cautiously in small steps, as there is imperfect knowledge as to how market participants will react.
In terms of timing, we think it likely that at the June ECB meeting there will be an announcement related to QE beyond September.
This will involve the ECB tapering QE from its current €30bn by €10bn per month in the fourth quarter, bringing net asset purchases to an end in December this year.
The ECB will then at the September meeting reveal forward-guidance on interest rates that will keep alive the prospect the first rate-hike can happen as early as mid-2019.
That said, we wouldn’t be surprised if the first increase comes later than that, and still think there remains a distinct possibility that ECB head Mario Draghi will not have overseen a rate-increase in his eight-year term as ECB president by the time he departs office on October 31, 2019.
That, of course, would be good news for Irish mortgage holders.
Meanwhile, as things currently stand, the Bank of England is expected to hold interest rates steady at its policy meeting on Thursday and hike by 25 basis points or by a quarter percent on May 10, with a further quarter-point increase priced in for late 2018.
With Brexit uncertainty receding, some of the nine UK central bank’s Monetary Policy Committee members see an opportunity to hike earlier and by more.
Follow-through on this sentiment should lift the pound against the dollar and euro in the near-term.
Although the ECB removed its easing bias from its March 8 policy statement, its static rate bias is likely to weigh on the single currency.
With the Bank of England set to maintain a hawkish bias this week and harsh Brexit fears waning, upcoming EU summit notwithstanding, the pound looks set to end March on a stronger footing.
Brexit optimism is boosting sterling and it could spike higher if the EU and Britain agree a Brexit transition deal at this week’s leaders’ summit.
The UK’s Brexit secretary David Davis fuelled the positive mood after he told BBC’s Newsnight programme last week he was prepared to accept the EU’s demand that a transition deal should conclude at the end of December 2020, and his main priority is to secure agreement this week.
If the outcome of the UK’s meeting with the EU’s chief Brexit negotiator Michel Barnier is positive, it could tee up further gains for sterling — which rose to a two-week high against the dollar and euro in recent days.
Alan McQuaid is chief economist at Merrion Capital.