Is the ECB Rethinking Tapering?

Andamento del mercato - 19/09/2017

Headlines emerging from Reuters this afternoon indicate that the Governing Council of the European Central Bank is extremely worried about recent Euro strength, and the havoc it could wreak on the outlook.  After a strong inflation report on Monday, alongside the positive wage gain developments recorded late last week, speculation was high that the ECB would announce some form of tapering during the October meeting, or at the very least discuss the impending possibility.

However, the concurrent appreciation in the common currency, parallel to ongoing economic momentum means that the ECB may hold off on tightening monetary policy to avoid potential fundamental shocks.  Any hawkish moves would likely fuel another leg of the current Euro rally while negatively impacting inflation and hurting export competitiveness.  Without inflation nearing the Central Bank’s target in a sustainable manner, it is hard to imagine an environment where tapering asset purchases would be a positive strategy for maintaining price stability.

Policymakers are keenly interested in a cheaper Euro because of the numerous advantages it provides for the monetary union.  If the currency is weaker on a trade-weighted basis, it makes the Euro Area more competitive from a global commerce standpoint, helping to buoy growth.  Furthermore, a weaker Euro raises import prices, which contributes to upside inflationary pressure.  These reasons are likely the rationale behind the divisions emerging between Governing Council officials.

Complicating the outlook are current forecasts for modest 0.90% annualized price growth during the first quarter of 2018.  With inflation projected to remain below the target for the foreseeable future, it is highly unlikely that the ECB would begin tapering ongoing asset purchases until price stability standards are satisfied.  Even though the Central Bank could potentially discuss the matter during the October meeting, policymakers are unlikely to form any consensus. This could presage “wait and see” tactics until inflation shows enduring gains. As a result, the ECB will find itself caught in a tradeoff between higher growth or a stronger currency as normalization pressure grows.

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