ECB June meeting
Divergent objectives are building that will likely make the June European Central Bank meeting critical. Interestingly, ECB board members have been noticeably quiet on “normalization” in light of the rapidly shifting economic & political backdrop. We believe that the outcome of the June meeting should provide insight into the mindset of Draghi & Co for the timing of any QE tapering and interest rate hike expectations.
On the top level, given weak incoming fundamental data, the ECB should need more evidence of direction before signaling policy path. Last quarter’s deceleration of European growth, illustrated by broad-based fall in the May Flash PMI, will hurt the GDP growth outlook. Concurrently, weak underlying price pressures sent core inflation back towards cycle lows. The corporate line, reiterated by the governing council, is that risks are transitional and balanced. Given the soft-patch, no one would be confused by an ECB pause in hawkishness. With economic worries haunting, the risk is increasing that an anticipated June or July message of a tapering to end asset purchases might be delayed.
However, political risk and hype is building in Italy, Spain and Greece (not to mention geopolitical issues), which might change the council member’s minds. The recent sharp rise in interest rates on the periphery suggests tighter financial conditions for the region’s weaker nations. On the surface, this would also suggest a further reason for a delay in ECB’s quest for “normalization.” Still, we suspect that the threat of a shock will only strengthen the ECB’s desire to get policy off the bottom.
The reality is the ECB has few policy options to manage a crisis. Interest rates are already negative and bond buying is already running into supply issues. As with the Fed in 2013, the need to remove extreme policy to regain policy firepower outweighed temporary economic weakness. Given the weakness in EURUSD, we suspect the market is underpricing the ECB commitment to “normalization.”