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  • Q2 GDP of 2.2% beats forecasts but unlikely to dramatically accelerate taper
  • Inflation concerns underscored by natural energy price shock
  • ECB governing council may compromise, with some slowing of APP but not PEPP 

Our ECB preview is focused on Thursday’s European Central Bank (ECB) governing council meeting on monetary policy. It will make its decision on interest rates but more closely watched will be its thinking on the timing of the tapering of asset purchases.

Its decision-making has been complicated by the hot inflation reading last week and today’s beat on GDP quarter on quarter growth coming in at 2.2% versus the 2.0% expected.

Last week Euro Area  inflation unexpectedly jumped to 3.0%, even after accounting for a number of one-off factors and distorting base effects.

Recent data, therefore, is grist to the mill for the hawks at the ECB who worry about an over heating economy, despite the wide variations in the performance of the economies of the various countries in the Euro Area.

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ECB may delay any big decisions

EUR/USD is weakening going into tomorrow’s council meeting, currently pressuring 1.1800. Forex traders should expect more weakness on Thursday if the ECB stays largely unchanged on tapering, notwithstanding some slowing in the rate of asset purchases from the Covid-specific emergency levels.

Commenting on higher than expected eurozone GDP and employment figures, Jesús Cabra Guisasola, Associate at Validus Risk Management, said: “While euro-area central bankers have been mostly united behind the measures taken to sustain the eurozone through the Covid-19 recession, the return towards normality is splitting the consensus with the hawkish central bankers starting to raise their voices for a scaling back of the stimulus.”

Guisasola continued: “The Governing Council will need to assess on Thursday whether the spread of the Delta variant continues to be a threat or if a slower pace of the bond purchases is needed to get inflation under control.

“Nevertheless, risk continues to be on the table as the pandemic is leaving a legacy of high debt and weak balance sheets, and a scaling back of the stimulus could disrupt the funding market and the uneven recovery of the eurozone.”

Adding to the difficulties around taper timing were the weak US non-farm payrolls numbers last Friday that unsettled the market, although the poor labour market data had been predicted by forexcrunch.

Any expectation of a start to tapering in September is now for the birds. However, the US Fed could still begin running down asset purchases in November or December this year, depending on the data picture.

For the ECB’s part aside from assessing the state of the economic recovery and the attendant Covid risks, the policymakers will need to consider the implications of being out of step with the Fed – if the Fed doesn’t move this year on tapering but the ECB does, then that could leave the European economy exposed if the recovery stalls, as it finds it has moved too early.

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ECB governing council monetary policy meeting, 9 September – it’s all about inflation

Looming over the governing council deliberations is the re-emergence of inflation. No longer is avoiding deflation the watch word. Instead policy makers worry that the elevated inflation levels will turn out not be transitory.

Adding to those worries is what is happening in the global supply chain. From autos, to furniture making, shortages are affecting all areas of the economy and that is leading to pressure on prices.

Europe is looking at currently dealing with a natural gas price shock that will only get worse as we head into the high demand winter season.

Shipping costs are going through the roof too and those costs are likely to be fed through to consumers eventually.

Bundesbank chief Jens Weidmann is of the view that the inflation risks are rising and that the stimulus taps should be slowed gradually, especially when the pandemic emergency purchase programme (PEPP) is curtailed.

“We have to watch the risks to the outlook for prices. In my view, upside risks predominate,” said Weidmann last week.

ECB likely to fudge the tapering timing issue

But the ECB could decide to fudge the issue.

“Governing Council members all appear to have different definitions of when the ‘crisis phase’ could be deemed to have ended,” BNP Paribas’ Paul Hollingsworth and Spyros Andreopoulos wrote in a note to clients. “Where we see the biggest risk is that by December or January the Governing Council still hasn’t come to an agreement.”

Last week Governing Council members Robert Holzmann and Klaas Knot took the view that the inflation outlook is such that tapering should now begin.

But those hawkish sentiments are likely to be over ridden by concerns about the Delta variant hurting the recovery.

Governing council members Philip Lane and Isabel Schnabel remain of the view that too low inflation remains more of a risk than inflation being too high.

ECB council members to split difference between APP and PEPP

The policymakers may decide to split the difference between the PEPP and the extended asset purchase programme (APP).

That at any rate is the view of Piet Christiansen, chief strategist at Danske Bank, even if the hawks are growing restless. “Now as ‘normality’ is coming back, they’re seizing the opportunity to make their voices heard again.”

Christiansen thinks a compromise is the most likely outcome of the meeting. So there could be a slowdown in APP which was accelerate earlier in the year as part of the emergency response to Covid, while the battle over PEPP is delayed until December or later.

For ING analysts Carsten Brzeski and Antoine Bouvet it is all about the definition of the P in PEPP.

“Looking for any tapering clues it will be important how the ECB defines the ‘P’ of the PEPP, which stands for pandemic and not permanent (asset purchases), and the end of the pandemic. Is it related to herd immunity, the number of infections, the economy returning to pre-crisis level or inflation returning to its pre-crisis path? Or something else. Up to now, the PEPP will run until March 2022.”

In conclusion then, don’t expect anything dramatic to come out of tomorrow’s ECB governing council meeting in a hawkish direction. Instead, forex traders in the coming days and weeks would do well to watch for any signs of inflation sticking around somewhat longer than the projected transitory timescale expected by the council.

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