Eurozone: What Draghi omitted? - ING

Peter Vanden Houte, Research Analyst at ING suggests that the market impact of Draghi’s Jackson Hole speech was mainly caused by what was actually missing.

Key Quotes

“No one had really been expecting that the ECB president would give some guidance on upcoming policy changes. But there was at least a feeling that Draghi could have taken advantage of the occasion to dampen expectations of a more hawkish policy stance, which are currently strengthening the euro exchange rate.”

“From the minutes of the last ECB policy meeting it appeared that the Governing Council expressed concerns about the risk of exchange rate overshooting. With Draghi remaining silent on the matter, markets felt that the pain threshold was still not being reached, pushing the euro even higher.”

“That said, the economy is doing fine, though the strengthening of the exchange rate is likely to prevent a further acceleration of GDP growth. The composite PMI for the Eurozone stabilized in August, while the German Ifo fell back somewhat, as did the Belgian leading indicator (often considered a bellwether for the Eurozone). On the other hand, the Economic Sentiment Indicator was a bit stronger in August. In that regard we still feel comfortable with our assessment of a quarterly growth rate around 0.4% to 0.5% in the second half of the year, yielding a 2.0% for 2017 as a whole.”

“The ECB is facing a difficult exercise. In a number of countries the opposition against quantitaive easing (QE) is growing. The German Constitutional Court requested the advice of the European Court of Justice on the question whether QE doesn’t violate the prohibition of monetary financing of government debt. In a recent interview, Bundesbank President Weidmann pleaded for a swift exit from QE. The bond scarcity issue in some member states is limiting the ECB’s capability to extend it much further anyway. A fading out of QE will therefore have to be announced in September or October, but it will have to be done in such a way that it is perceived as dovish to prevent the euro from strengthening further and to avoid what the ECB often refers to as “unwarranted tightening of financial conditions”.”

“The best option could be a tapering announcement to reduce the monthly purchases from €60bn currently to €30bn starting January 2018 for at least six months combined with an extension of the list of eligible assets for QE purchases. This could exactly be what the minutes of the last ECB meeting described as “the Governing Council needed to gain more policy space and flexibility to adjust policy and the degree of monetary policy accommodation, if and when needed, in either direction”. We don’t think that the stronger euro will prevent the ECB from eventually moving towards tapering, though a somewhat slower pace of tapering (eg, reducing to €40bn) could be the wildcard if the strengthening of the euro would continue.”