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Draghi’s ECB may take ‘baby steps’ toward ending ultraloose monetary policy

“Forward guidance” remains the name of the game when the
European Central Bank meets Thursday.

When ECB President Mario Draghi begins his news conference
following the Governing Council meeting, in which the central
bank is seen as virtually assured to leave monetary policy
unchanged, his opening statement will be scrutinized for any
subtle changes to language laying out the timetable and pace of
the ECB’s asset-purchase program and rates.

Should investors look for changes?

On the one hand, for those pining for the ECB to bring its
asset-buying program to an end and set the stage for eventual
rate increases, economic data across the eurozone continues to
impress. In fact, the ECB’s forecast for economic growth of
1.8% in 2017, which was previously above consensus, now looks a
bit cautious, noted Ben May, lead eurozone economist at Oxford
Economics, in a Tuesday note.

That means Draghi is likely to tell reporters Thursday that
risks to the economic outlook are now broadly balanced, May
said. In central banker lingo, that’s an important shift from
Draghi’s previous description of economic risks as “still
tilted to the downside.”

The rub, however, is that while the economy may be picking up
steam, inflation isn’t, May noted. And hitting the annual
inflation target of near, but just below, 2% is the ECB’s only
mandate.

Indeed, lower oil prices and a decline in food commodity prices
over the past three months should lead ECB staff to lower their
headline inflation forecast, said Pernille Bomholdt Henneberg,
chief analyst at Danske Bank, in a note (see charts below).

In a note entitled “Baby steps toward normalization,” analysts
at Bank of America Merrill Lynch argued that if it were solely
about the data, the ECB would probably do little more than
acknowledge that risks to the economic outlook have turned
neutral from negative.

But they expect the ECB to go a little further and remove “some
of the symmetry” from the forward guidance Draghi provides in
his opening statement. How so? They expect the ECB to drop
language emphasizing that policy rates could still go lower if
warranted.

That will still make for a “dovish” message, the analysts
noted, adding that there’s a risk the ECB could instead
indicate no change at all to forward guidance.

Meanwhile, the ECB is unlikely to alter its commitment to
buying 60 billion euros a month of government and corporate
bonds until “at least” December 2017, they said.

Peter Schaffrik, chief European macro strategist at RBC Capital
Markets, laid out a similar scenario, with the ECB only
removing its warning that rates could go lower if warranted.

If so, the market impact is likely to be “rather limited,”
Schaffrik said, noting investors have already scaled back
expected rate increases (see chart below).

“For markets, we think the real discussion will only arise once
the future of [quantitative easing’ has been debated — and this
is unlikely to happen at this meeting,” he wrote.

The euro

EURUSD, -0.0709%

 might also remain relatively calm, even if the ECB does
introduce a “slightly more hawkish” statement, Danske Bank
analysts said, arguing that the key for forex markets will be
any eventual signal of a change in the ECB’s stance on policy
rates and that the first move toward an exit from negative
rates is being contemplated.

Meanwhile, further rate increases by the U.S. Federal Reserve
and a commitment to unwinding its balance sheet could lead to
euro softness versus the dollar in coming months, they said,
arguing that “it will not be until the ECB removes its
commitment to negative rates that the EUR/USD will see the next
round of fundamental correction higher; this should be a story”
for the second half of 2017.

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