ECB preview: when will the taper talk begin?

The ECB is back in the frame. With the French election expected to resolve in favour of stability, will we begin to see a more hawkish ECB?

Mario Draghi ECB president
Source: Bloomberg

This Thursday sees Mario Draghi, president of the European Central Bank (ECB), take centre stage again, in what is likely to be yet another volatile day for the euro. Much has changed since the last meeting in March, including the first round French election results coming in over the weekend. Interestingly the decision-making in March was dominated by two issues: political risk and inflation. To some extent we have seen both risks eased significantly. While inflation was at 2% last month, Draghi focussed instead on the core figure, which remained depressed at 0.9%. However, we have since seen a sharp fall in the price growth, with headline inflation falling to 1.5% and core CPI down to 0.7%. To some extent, the inflation pullback will allow Draghi to maintain a more accommodative stance for a while. Meanwhile, with the recent French election result, we are now looking at a relatively carefree EU after both Netherlands and France voted for a pro-EU leader.  

The big question here is when we will hear from the ECB regarding a potential tapering of the current asset purchase facility. Draghi has already said that the eventual unwinding of the quantitative easing (QE) programme will involve a tapering of the asset purchase size, timeline of which we will have to see laid out in advance. With that in mind, it is always worth noting that at some point, we will face the repercussions of a more hawkish Draghi, and the market response to such an event. Will it be this week? Probably not.

That said, there is no doubt that the eurozone economy has been picking up significantly, and with that comes the expectation that the ECB may have to act, particularly in the face of rising inflation. Given that we are coming from a position where the ECB is highly extended on the side of stimulus, any shift towards a tighter monetary policy would be likely to strengthen the euro significantly. The EUR/USD weekly chart below shows that we have already been on a path of strength over the first four months of 2017, with the two-year range remaining in play. The creation of higher highs and higher lows from the bottom of that range points towards the potential for significant further gains. The key hurdle now is $1.0906, as a break above that level would signify a continuation of this four-month uptrend. We are expecting much volatility this week, given the aftermath of the French election, Donald Trump’s tax reform announcement tomorrow, and the ECB announcement on Thursday. Thus, watch out for the $1.0906 level, given that a break through this would likely pave the way for further gains over the coming weeks or even months.

There is no doubt that with Brexit and the second round of the French elections up ahead, there is still a significant degree of political risk that the ECB will have to account for. However, given the expectation that the French election will follow the Dutch in supporting the European project, we are seeing the 2017 clouds finally clear in favour of stability. Whether that pushes the ECB into a more hawkish mindset remains to be seen.

One thing to remember for this meeting is that Draghi loves to talk the euro down. Considering its strength we have been seeing of late, it would not be surprising if we saw Draghi push back any taper talk for now, in a bid to lower the euro. 

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