ECB likely to change policy tone in spring of 2018, says BoFAML

The European Central Bank (ECB) is expected to change its monetary policy tone in the spring of this year. The first step would be to sever the link between inflation dynamics and the continuation of QE – as Benoit Coeuré has been advocating – while re-pegging the inflation conditionality on policy rates directly, according to a recent report from BoFAML.

The risk though at that point is that the hawks seize the occasion to demand more, for instance, a removal of the notion that no rate hike could be implemented before “well past” the end of the net purchases.

The Fed, too, ended QE before inflation was firmly re-established. Looking further ahead, we think the ECB will end up emulating the Fed, which did not wait for inflation to be firmly re-established before first ending QE, then hiking rates. To a growing number of Governing Council members, once the real economy does better, it becomes difficult to maintain the “unnatural” arsenal of QE and/or negative policy rates.

"We maintain our baseline that the net purchases stop in December 2018, before a first deposit rate hike to -20 bps in Q2 2019, then to zero in Q4, with the refi rising by 25 bps, even though we remain very bearish on inflation. This puts us, quite unusually, above market pricing, despite being more patient than the consensus of economists. We think the ECB is hitting its limits faster than what the market thinks," the report added.

Lastly, FxWirePro has launched Absolute Return Managed Program. For more details, visit http://www.fxwirepro.com/invest