LONDON (Reuters) - By now, the ECB’s dilemma is familiar. Growth in the euro zone is ticking a long at a pace that should allow it to start winding down its massive stimulus programme, but inflation - the product of a strong euro and stagnant wages - remains stubbornly below levels deemed healthy.
With that in mind, ECB President Mario Draghi is merely expected to start laying the groundwork for stimulus reduction when policymakers meet on Thursday, giving investors some hints but probably holding off on any major commitment.
Draghi is considered certain to ask the ECB’s committees to prepare policy options for the coming meetings - a signal that has in the past preceded actions. Some also expect him to tweak the bank’s longstanding guidance on asset buys, giving up a reference to the option of raising asset purchases. Another option is to leave in the reference for increasing purchases but add a reference to a cut, making the guidance more neutral.
Markets will also watch closely for his response when asked about the strong euro. The ECB announces its rate decision at 1145 GMT, followed by Draghi’s news conference at 1230 GMT.
Britain's parliament will today start debating the "main principles" of the so-called repeal bill, which while repealing the 1972 act that took Britain into the EU will also largely copy and paste EU law into British legislation for the initial years after Brexit. Lawmakers will vote on Monday on whether the bill can move on to the next part of its long legislative journey, when plenty of amendments are expected. Brexit Minister David Davis opens the debate shortly before midday.
Turkey's EU Affairs Minister Omer Celik will hold what could be prickly talks with European Union foreign ministers meeting in the Estonian capital Tallinn today and tomorrow. The talks coincide with heightened tensions between Ankara and Berlin. German Chancellor Angela Merkel warned on Tuesday that Turkey was drifting away from the rule of law fast and vowed to push her EU partners to consider suspending or ending its accession talks at an October meeting. Turkey's leader Tayyip Erdogan, mindful of how important a strategic partner his country is for the Europe, has defied the EU to go ahead and make such a move.
As financial markets home in on Thursday’s European Central Bank meeting for any nods and winks about the timing of the ECB’s stimulus withdrawal, Canada’s surprise interest rate rise on Wednesday reminded everyone that G7 monetary settings will not remain super-easy forever. It also showed the very clear implication of policy tightening right now - the Canadian dollar surged more than 2 percent at one point to its highest levels in two years.
And that’s the ECB’s main conundrum today. All the economic activity signals suggest it should take its foot off the gas, but the 13 percent surge of the euro already this year is playing havoc with its sub-target inflation outlook and it will want to step lightly for fear of compounding the problem with another exchange rate jump today. Best guess is that it uses its new staff forecasts to give it cover for more concrete tapering steps to be announced in October, while reserving the right to be flexible with that while assessing the risk of an overshooting euro.
The FX reaction today then may well be the biggest story. Euro/dollar is firm about $1.1920 as we head into the meeting. The flipside to that equation is the dollar of course and the greenback remain on the backfoot across the board.
Wall Street’s North Korea wobble lasted just one day and the S&P500 bounced back 0.3 percent overnight, with the ViX equity volatility gauge slipping back below 12 percent. Added relief came from the U.S. President Trump’s bipartisan agreement to lift the debt ceiling for another three months to year-end as he secured additional funds for hurricane relief in the southern states. While it takes a debt showdown off the radar for next month, it ups the ante for December instead – with possible implications for the timing of the next Federal Reserve interest rate hike. At the moment, markets see a one-in-four chance for a third 2017 rate hike by December.
The surprise decision by Fed Vice Chairman Fischer to stand down from his role next month also removes a relatively hawkish voice from the central bank’s top ranks, leaving the whip hand with those who over the past week have indicated a preference for leaving rates on hold until inflation shows more signs of life. Ten-year U.S. Treasury yields bounced back on Tuesday on the debt ceiling developments, equity rally and firmer US business surveys but have ebbed slightly again this morning.
On the North Korea story, the international bias is still toward sanctions and more diplomacy rather than any suggestion of military action. Asia markets were mostly firmer, led by a rally of more than 1 percent in Seoul’s Kospi. China and HK stocks underperformed, with the yuan rising again for the ninth straight session and raising questions about how much more currency strength Beijing will tolerate.
Sweden’s Riksbank - which like its Canadian counterpart is monitoring rapid domestic house price gains – also makes a policy decision today. The consensus is it will keep its super-loose monetary stance for now and will likely wait and see the ECB’s next move first.
editing by John Stonestreet