Morning Commentary: The European Central Bank: Waiting for June
A daily summary and commentary of events and factors that affect the global markets, with a particular emphasis on the foreign exchange markets.
The European Central Bank: Waiting for June
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Andrew Kositkun Senior FX Advisor
Earlier this morning, the Bank of Canada (BoC) announced that it would keep its benchmark overnight rate at 0.25%. Growth forecasts were revised higher with the bank now seeing inflation at target in 2022. The BoC also announced that it would pare back asset purchases by one-quarter and indicated that it could bring forward its timeline for interest rate hikes. Market focus now turns to the European Central Bank (ECB) which will announce its latest policy decisions tomorrow morning.
Recent economic data has been positive but reflects conditions preceding extended lockdowns. Europe’s virus situation remains fragile, but vaccinations have accelerated. The ECB remains concerned about uncertainty surrounding Next Generation EU (NGEU) ratification and has reiterated the need to deploy NGEU funds quickly. Overall, there is little reason for the central bank to change its outlook or its balance of risks, especially after it already delivered on its promise to accelerate purchases.
Broadly speaking, this week’s meeting should be a placeholder meeting ahead of the much more eventful June decision. Between now and then, there are two important challenges ahead of the ECB’s June meeting. First, if uncertainty around NGEU ratification persists, or if it gets resolved in an unfavorable way, market will could stop being constructive on risk, forcing the ECB to take action.
Second, if reopening is able to start sometime in May and if activity improves, markets could start to test the ECB’s tolerance of rising yields and force the central bank to clarify its reaction function at its June meeting. For now, Christine Lagarde, president of the ECB, will likely avoid discussing what reopening scenarios will mean for the pace of purchases through the pandemic emergency purchase programme (PEPP) during the second half of 2021. Most likely, Lagarde will just note that the outlook and the pace of purchases will be jointly assessed.
Markets are also waiting for the outcome of the ECB’s ongoing strategy review. The outlook for the eurozone economy has deteriorated this year, largely because of slow vaccinations. The EU recovery fund has also been delayed due to questions raised by the German Constitutional Court (GCC). While GCC questions appear to have been cleared, other hurdles still remain. Ultimately, the recovery fund is expected to pass, but these issues highlight underlying eurozone weakness, and delays already limited available funding this year.
The ECB has also continuously missed its inflation targets, and inflation expectations suggest that inflation will not move to target levels for the foreseeable future. Yet the ECB has yet to explain how it defines “favorable” and what financial conditions it targets. Recent comments from ECB hawks also point to risks for early policy normalization. While these hawkish comments might represent ongoing strategy review discussions, strong disagreements on policy amid a negative outlook and a policy-constrained central bank lead to questions around the ECB’s ability to meet policy goals.
For now, markets are hoping that the strategy review will provide policy clarity. On one end, the ECB can clarify how an open-ended quantitative easing (QE) program can continue after the PEPP ends next year. On the other end, the ECB can signal that the end of PEPP will also bring the end of QE. Where we ultimately end up in the middle of these two extremes will set the tone for where the euro is heading.
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