ECB on track to loosen policy at December meeting

Since President Draghi's 22nd October announcement that an easing of monetary policy would be considered at the ECB's December meeting, which is now less than two weeks away, indicators of euro area financial conditions have softened appreciably. For example, the trade-weighted euro has fallen by nearly 4%, the Euro Stoxx index has jumped by over 5% and 2-year government bond yields have declined to a record low.

On top of these, the 5y5y inflation swap rate has extended its rebound since late September. However, we continue to anticipate that policy will be loosened next month for two reasons. First, the easing in market conditions largely reflects the ECB's dovish signal and there is a risk of a sharp reversal if they do not follow through. Second, the economic data continue to suggest that the euro area recovery is waning.

Combined with the possibility that the current spell of very weak inflation outturns could result in a de-anchoring of inflation expectations, this "dangerous cocktail" - in the words of ECB Chief Economist Peter Praet - could easily morph into a deflationary spiral. Some ECB council members are likely to argue for waiting while the impacts of the current QE programme feed into the real economy.

"We do not expect their case to be helped by the coming week's releases which are dominated by sentiment surveys for November. For example, the preliminary euro area PMIs and the German IFO are set to indicate that the softening of activity seen in Q3 will linger into Q4", says Lloyds Bank.