Thoughts About The ECB And Euro

Mario Draghi's term at the helm of the ECB is winding down.  He will step down in October. It has not been an easy job. The light at the end of the tunnel in 2017 turned out to be another train in 2018. The eurozone enjoyed a 0.7% quarterly growth every quarter in 2017. The ECB was able to outline an exit from its asset purchases. The debate began over sequencing and when the first rate hike could be delivered.  

But alas, the cyclical recovery fizzled and in the second half of 2018, the German and Italian economies contracted. Price pressures eased. At the last meeting, the concerns had reached a point that the ECB took unprecedented action and downgraded its risk assessment before the staff provided updated forecasts.  

The staff has to make good on this at this week's meeting. In December, the ECB forecast 1.6% CPI and 1.7% GDP growth. Both will likely be revised lower. We suspect that CPI projection will be shaved by 0.1%-0.2% and the GDP to be marked down to 1.2%-1.4%. It is, arguably, preferable to have to lift the forecasts in the future rather than cut them again. The extent that the 2020 forecasts are revised, however, may offer more insight into the mood of policymakers and their level of concern of the risks this slowdown does continue to evolve into an outright contraction.  

Even if the cart was before the horse, the combination of the changed risk assessment and the updated forecasts require a policy response. The policy response will more nuanced than a change in rates. There are two levers. Forward guidance and a new loan facility

Forward guidance in this context refers to the ECB's pledge not to raise rates until after this summer. The market long pushed the first rate hike into 2020. The ECB could confirm and validate these expectations. However, it might not be in a hurry given that the market has already done the heavy lifting and it touches on a sensitive issue, and that involves pre-committing Draghi's successor. Recall that at Draghi's first meetings, he unwound Trichet-led hikes.  

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Read more by Marc on his site Marc to Market.

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