ECB Preview: Trying Not To Get Lost In Transition

Confidence indicators are still falling but there is some bottoming out in sight. With that in mind, the ECB next week will have to balance between pre-emptive action, which could be perceived as panic, and a relaxed wait-and-see attitude, which could be perceived as complacency.

Source: Andrej Klizan

When the European Central Bank meets next week for its March policy meeting, the jury on the actual state of the eurozone economy is still out. Since the January meeting, most confidence indicators have continued their downward trend, which started last summer, but recently some tentative signs of stabilization have emerged. Whether these are credible green shoots of a bottoming out to be followed by a rebound in the economy, or simply a pause in the continuing deterioration, is simply too early to tell. 

The latest ECB staff projection are very likely to show a downward revision of 2019 GDP growth (1.7% in the December projections). However, any revision which does not go lower than the current consensus of 1.4% is simply proof of the ECB’s sense of reality and no reason to panic. Any significant downward revisions to the ECB’s 2020 and 2021 GDP growth forecasts (1.7% and 1.5% in December) would be a much more alarming signal, particularly as this time around any changes to the forecasts would be mainly driven by changes in the fundamental assessment of the economy and not by revisions to the technical assumptions. Compared with the December projections, there should be no new impulse from oil prices. The effective exchange rate and bond yields are somewhat lower but not low enough to push growth and inflation forecasts higher. This, in our view, also means that there will be hardly any changes to the ECB’s staff projections for inflation (1.6%, 1.7% and 1.8% for the period 2019-2021 in the December projections).

Even though the latest round of ECB staff projections was supposed to provide more clarity and guidance, chances are high that the ECB next week will not be able to judge whether the current downswing is transitory or more structural. In fact, the only thing that is for sure right now is that the transitory period is lasting longer than the ECB had anticipated. For the rest, the eurozone still wobbles between decent domestic demand and increased external risks, and it remains unclear, in which direction the pendulum will eventually swing.

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