Dovish APP bias dropped, little news on policy outlook

ECB decisions and communication provided little news last week, and were closely in line with our expectations. The ‘dovish bias’ on the APP (ECB Asset Purchase Program) was dropped as we expected , but ECB President Draghi emphasised that this reflected “backward looking” observations which had little signal value for future policy . The Governing Council has increasing confidence in economic growth and that this reduces the variance around future inflation paths. But, the Governing Council views underlying inflation as subdued and therefore patience and persistence in policy is required. Overall, Mr. Draghi said the Governing Council had little discussion about future policy at the March meeting. Mr. Draghi made some explicit remarks about the negative effect of protectionist trade measurers. The ECB maintained a reference to the exchange rate in its Introductory Statement. The updated staff macro-economic projections showed minor changes, and  near-term growth revised higher and next-year inflation lower. We expect no interset hike until the second half of 2019.We highlight the key point below.

The Introductory Statement showed that the ECB maintains a broadly unchanged positive view on economic growth. Risks to growth are still seen as balanced . The Introductory Statement noted that new information “confirms” the strong and broad-based economic growth in the Euro area, with some faster-than-expected growth in the near term. The updated macro-economic staff projections lifted the GDP growth forecast for this year . On potential growth, Mr. Draghi noted that the Governing Council had discussed uncertainty around potential growth and how high current growth may raise potential growth via positive supply side effects. If this is the case, high growth and low inflation can be observed together for longer.

On inflation, the Introductory Statement noted, as widely expected, that inflation has “yet to show more convincing signs of a sustained upward trend“. The statement still highlights that “an ample degree of monetary stimulus remains necessary for underlying inflation pressures to continue to build up“. The assessment of underlying inflation as being “subdued” remains unchanged . That said, the strong growth confirms the Governing Council’s “confidence that inflation will converge towards” the inflation aim. The updated macro-economic staff projections revised down headline inflation for next year by 0.1pp to 1.4%. The headline inflation forecast for 2020 remains low, at 1.7%.

The Introductory Statement explicitly notes rising protectionism as a downside risk to growth. Mr. Draghi highlighted the possible effect of protectionism via higher uncertainty on confidence and how this could negatively affect economic growth and inflation. Developments in the foreign exchange market were also highlighted as a source of downside risk to growth, and the Introductory Statement mentions that the Governing Council will monitor developments in the exchange rate and in financial conditions with regard to the effect on the inflation outlook.

And there was no direct news on how the forward guidance or the APP may evolve. Mr. Draghi was keen to emphasise that the framework established with the sequencing of no rate increases until ‘well past’ the end of net asset purchases is “set in stone“. Mr. Draghi provided little news about when new information on forward guidance or the extension of the APP may be announced. Mr. Draghi highlighted again the importance of the APP flows in terms of its guidance for the policy rate outlook via the sequencing commitment.

We estimate that growth will likely fall slightly by mid-2018, and, more importantly, that inflation will remain muted. On this basis, we expect the ECB to extend the APP by three months with gradually tapered purchases between September and December, and thereby signal no hike before mid-2019. Risks are still skewed to no extension, but recent comments by various Governing Council members suggest a 3-month tapering should not be controversial. We see the removal of the dovish APP bias as having little signal value about whether the APP will continue beyond September. We think the updated forward guidance — which increasingly looks unlikely to be announced until June or even later. On our low inflation forecast, this implies no rate increase until mid- to the second half of 2019.