When the Governing Council of the ECB meets this week, it will be facing a less favorable growth outlook, no signs of core inflation trending higher and nervous financial markets. The truce between the US and China will buy time but does not fundamentally ease trade concerns, while in Italy the situation remains fragile with sovereign spreads still very wide and the economy flirting with recession. Recently, the only unambiguously good news has been the sharp drop in oil prices, mainly supply-driven, which will contribute to supporting eurozone economic activity in the coming months at a time of intensifying downside risks.

This assessment is likely to be reflected in a more cautious tone by ECB President Mario Draghi and in the ECB’s updated macroeconomic forecasts, which will probably show a downward revision to GDP growth for 2019 and 2020 from 1.8% and 1.7%, respectively, to somewhere in the 1.5-1.7% range. The latest data have confirmed that the ECB’s projections for core inflation remain too optimistic; the possibility of a further slight downward revision there, together with lower oil prices at the cut-off date, pose downside risks to the inflation forecast for the next two years, which currently stands at 1.7%. Numbers for 2021 will be published for the first time and they will probably show GDP growth settling at about 1.5% (broadly in line with the estimated potential growth rate of the economy) and inflation at 1.7-1.8%. It should be considered that some of the recent slide in oil prices occurred after the cut-off date used to determine the exogenous inputs to the ECB’s models. Therefore, the new forecast numbers will not fully reflect the scale of the correction in oil prices.

Despite the assessment turning less favorable, the Governing Council is very likely to call an end to its net asset purchases, reflecting the progress made so far in boosting economic growth, closing most of the output gap and stimulating wage formation. With the risk of outright deflation sharply reduced since the inception of QE and with technical constraints increasingly biting, an emergency tool such as net asset purchases is rightly regarded as having run its course.

However, financial conditions will have to remain very accommodative. Therefore, the ECB will probably take the opportunity to enhance its reinvestment guidance, at least by clarifying the timeframe for rolling over maturing assets. The current generic wording, that reinvestments will be carried out “for an extended period of time” after the end of net purchases, might be replaced with a statement suggesting that reinvestments will last for at least two years after QE is terminated – as a reference, the Fed’s full reinvestments lasted for three years after the end of their QE. The ECB’s chief economist Peter Praet recently noted that the market expects reinvestments to continue for two-to-three years. We doubt any change in the ECB’s guidance will challenge this expectation.

Liquidity support to banks will be another topic up for discussion this week, although our gut feeling based on the latest statements by Governing Council members is that an announcement might not come yet. We think the ECB will ultimately decide to extend TLTROs, probably by two years, at a less-favorable, variable interest rate. The rationale behind this extension would be twofold: first, it would allow the ECB to avoid a liquidity “cliff effect” as the residual maturity of outstanding TLTRO money starts to fall below one year in mid-2019, with negative consequences for banks’ net stable funding ratio. Second, it would support the transmission mechanism of monetary policy by easing funding stress for Italian banks.

Given how important timely guidance on liquidity policy is for banks’ funding plans, if the ECB does not make an announcement on Thursday, it will probably not wait for any later than March 2019. If Draghi signals his determination to preserve the transmission mechanism of monetary policy, this should be read as an indication that action on liquidity is in the pipeline.