April 23, 2018 / 6:07 AM / 2 years ago

Graphic - The long goodbye to easy money: Five questions for the ECB

LONDON (Reuters) - The ECB meets on Thursday against a backdrop of concern about a global trade spat and a softening in euro zone economic data that could potentially hamper the central bank’s plans to unwind its extraordinary monetary stimulus.

The European Central Bank (ECB) headquarter is illuminated during a preview for the Luminale light show in Frankfurt, Germany, March 16, 2018. REUTERS/Kai Pfaffenbach

In March, the European Central Bank dropped a long-standing pledge to increase its bond buying if needed, taking another small step in weaning the euro zone economy off protracted quantitative easing (QE).

Just how much recent economic and international developments are impacting the ECB’s plans to unwind QE could well make for a lively debate. Here are some of the key questions on the radar for markets.

1/ Will there be changes to forward guidance?

Probably not. Having taken another baby step last month towards unwinding the 2.55 trillion euro ($3.15 trillion) asset purchase scheme, the ECB is not expected to make any changes to its policy outlook on Thursday.

Still, discussions to future tweaks to the so-called forward guidance, which includes the ECB’s outlook on asset purchases and interest rates, could be on the agenda. The ECB is seen on track to wind up QE by year-end.

“It’s in the ECB’s interest to say and do nothing,” said Pictet Wealth Management economist Frederik Ducrozet. “We know communication changes are coming but the risk-reward is in favour of waiting until June or later before announcing next steps.”

(GRAPHIC - The ECB's QE programme, reut.rs/2HezxZQ)

2/ So can we expect a hawkish or dovish ECB?

More likely dovish than hawkish. Worries about a firm currency, a possible U.S.-China trade war and economic momentum slowing suggest ECB chief Mario Draghi is likely to sound a cautious note at the post-meeting press conference.

The ECB was quick to distance itself from recent comments by policymaker Ewald Nowotny that he would have “no problem” with lifting the deposit rate up 20 basis points to get rate hikes rolling.

Money market pricing suggests investors have pushed expectations for a rate rise further into 2019 and talk in January that the ECB could wind up QE in September when asset purchases are scheduled to end has proved short-lived.

(GRAPHIC - ECB deposit rate - Reuters Poll, reut.rs/2J7DhwS)

3/ How concerned is the ECB by a global trade war?

The risk of a full-fledged trade war between the United States and other major economies was on the ECB’s worry list last month and is likely to feature prominently once more.

For investors, the key question is whether the ECB’s carefully calibrated exit plan from its ultra easy policy could be scuppered by trade tensions, especially if the dispute between the United States and China sucks in the euro zone.

The ECB would have to alter its march towards a more normal policy stance if growing risks from protectionism, exchange rates or market swings end up depressing inflation, the ECB’s Francois Villeroy de Galhau said last week.

Trade worries are also starting to weigh on investor sentiment and growth forecasts.

(GRAPHIC - Trade war fears weigh on economic sentiment, reut.rs/2HdT8cU)

4/ Will the ECB address the softening economic data?

Indeed, recent weeks have seen further evidence that the euro zone economy has peaked and this is something Draghi is likely to be pressed on.

Euro zone firms ended the first quarter with their weakest expansion since the start of 2017, according to the March Purchasing Managers’ surveys. Inflation rose less than estimated last month and investor morale in powerhouse economy Germany has tumbled.

Still, the IMF last week raised its forecast for German economic growth and the ECB is likely to play down recent disappointing data, analysts said.

“With the weakening of economic surprises, there is less sensitivity around what the ECB is doing,” said Mizuho rates strategist Antoine Bouvet. “In a way, it’s a window of opportunity for the ECB to discuss changes and prepare the market for a change in the forward guidance.”

(GRAPHIC - Euro-boom over?, reut.rs/2K1Pyo2)

5/ What about the strong euro?

The euro’s rally at the start of 2018 has sputtered recently, bringing some relief to a central bank highly sensitive to any sign the strength of the single currency is sapping the competitiveness of its exporters.

But many investors remain bullish on the euro as investors put money back into the region, and the ECB may repeat concerns over the potentially harmful impact of euro strength.

On a trade-weighted basis the euro remains less than one percent below a 3-1/2 year high it hit on March 8, the same day the ECB last held its meeting. The euro also remains close to its strongest in three years against the dollar EUR=.

Analysts are divided about the impact a more serious escalation in tit-for-tat trade wars would have on the currency. German exporters could be hit hard but given the dispute so far is largely between Washington and Beijing any negative impact on two of the euro zone’s biggest trading partners would more likely hurt the dollar and yuan, boosting the euro.

(GRAPHIC - Euro strength: cause for concern?, reut.rs/2HLjt34)

Reporting by Dhara Ranasinghe and Tommy Wilkes; Graphics by Ritvik Carvalho

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