Tonight’s policy meeting of the European Central Bank’s governing council has taken on an added level of significance, given the recent strength in the euro.
At current levels this morning above $US1.19, the euro is trading near a three-year high against the US dollar.
That’s led to some speculation that ECB president Mario Draghi will use the occasion to announce a more dovish stance towards monetary policy.
Ahead of the meeting, Capital Economics analyst Jennifer McKeown has prepared an insightful analysis of the possible steps the ECB may take.
McKeown notes that despite the euro’s recent climb, Draghi has so far refrained from a direct attempt to talk down the currency.
While not ruling out the chance that Draghi will try to jawbone the currency lower, McKeown said such a scenario was unlikely.
She noted that while the ECB had intervened verbally multiple times since 2004, that had only happened when the euro was higher than it is now:
As the chart shows, each instance of ECB intervention took place when the euro had pushed above $US1.25.
“What’s more, experience has confirmed that words will have only temporary effects on the exchange rate unless they are accompanied by actions,” McKeown added.
And when it comes to action, the ECB is unlikely to reverse its current plan to begin tapering its bond-purchasing program. McKeown highlighted two reasons why:
“The Bank is nearing constraints on the amount of government bonds that it can hold and many Governing Council members have long been uncomfortable with the risk that they are financing excessive public borrowing,” she said.
McKeown added that rather than focus on a specific level for the euro to reach, the ECB is typically more focused on the extent of recent changes to the exchange rate.
But despite the euro’s 4% rise on a trade-weighted basis since July, McKeown said the effect of a stronger currency on Eurozone inflation would be minimal — and her conclusion was based on the ECB’s own scenario analysis.
That’s important because when it comes to setting monetary policy, the ECB has a sole mandate of 2-3% inflation. So the only likely driver for a dovish shift in the bank’s current policy stance would be a notable fall in the inflation fate.
McKeown said that if the ECB wants to reduce the currency-boosting effect of its tapering program, it could use tonight’s meeting to announce extended time-frames.
The current expectatation is for the current bond level of bond purchases — 60 billion euros a month — to reduce to zero from January to September next year, so anything longer may be considered more dovish.
Additionally, president Draghi could clarify the bank’s forward guidance on interest rates, “perhaps stating that interest rates will not rise until well into 2019”, McKeown said.
The Capital Economics team think either scenario is unlikely though.
While McKeown’s near-term prediction for the euro leans to the upside, Capital Economics still expects it to end the year below its current level.
“Our forecast that the currency will end this year and next at $1.15 is reliant on renewed tightening by the US Fed and some easing of geopolitical concerns and related safe haven flows,” McKeown said.
Tonight’s meeting is scheduled for 9:45pm AEST, with a follow-up press conference at 10:30pm AEST.