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Minutes of September MPC Meeting Point to a Dovish ECB

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Written By: Adrian Moore – Forex Focus

The European Central Bank could finally announce its tapering strategy this month. 

The European Central Bank (ECB) released the minutes of the September 6-7 Monetary Policy Committee meeting in the first week of October, revealing the division between policymakers who want the asset-buying program to be extended and those who want the tapering to get underway from January 2018. According to the minutes, policymakers established that growth in the euro area economy was broad-based, led by private consumption and investment spending, which was backed by steady income growth, favourable funding options and low interest rates. Real GDP (gross domestic product) growth in the eurozone, which increased by 0.6 percent in second-quarter 2017 from 0.5 in the first quarter, has led the central bank’s staff to raise its GDP forecast for 2017 to 2.2 percent.

The ECB contended that demand was backed by consumer spending and supported by labour growth in the eurozone, which has created around six million jobs since 2013, thereby giving a rise in household wealth. According to the minutes, the rise in compensation, or wage, growth slipped from 1.4 percent in 2016 to 1.2 percent in first-quarter 2017 on the back of wage negotiations in a number of countries within the euro area, which the bank pointed out would eventually give way as labour shortages rose. Likewise, an increase in corporate profits has led to investment growth, and the global recovery has lent support to exports in spite of a stronger euro. However, the central bank cautioned that developments in forex (foreign exchange) markets leading to an appreciating euro could eventually pose downside risks to growth and inflation in the medium-term.

The rise in HICP (Harmonised Index of Consumer Prices) inflation numbers from 1.3 percent in July to 1.5 percent in August was mainly due to higher food and energy prices, although an increase in input inflation did not lead to a significant transmission to output prices due to the stronger euro, the minutes stated. The ECB, while maintaining the HICP inflation forecast at 1.5 percent for 2017, has revised it lower by 0.1 percent for 2018 and 2019: to 1.3 and 1.5 percent respectively. Policymakers at the central bank sounded optimistic that economic expansion would gradually push inflation higher to the central bank’s targeted level of close to 2 percent, although the pace in inflation growth could take a while longer than what the bank had projected in June of this year. In view of the prevailing outlook on inflation, members will constantly evaluate to determine the extent of monetary-policy accommodation that may be required to guide inflation back to around the 2-percent mark in the medium-term.

On the global outlook, the ECB was of the view that most economies were expanding at a brisk pace, with external demand lending support to the economic growth in the eurozone. Conversely, the outlook for growth in global markets was subject to downside risks, as uncertainties about the macroeconomic policies of the United States, negotiations related to the United Kingdom’s exit from the European Union and adjustments in the balance sheets of a number of emerging economies could weigh in on the current market trends.

While the ECB credited its monetary policies to the ongoing economic growth in the euro area, it maintained that momentum could slip if favourable financing conditions were not met, suggesting that it may continue with its quantitative-easing (QE) or asset-purchase program (APP) for an extended period; and it is in no hurry to hike interest rates any time soon. The next monetary-policy meeting of the European Central Bank is scheduled for October 26, during which the governing council is expected to unveil tapering plans that they are likely to kick-start in January of next year. According to market expectations, the ECB should cut its QE by a third, to €40 billion a month from the current €60 billion. However, the minutes also established that the ECB is still open to an accommodative stance in terms of asset purchases in the event of inflation slipping below the projected levels of the central bank or in the event of an unfavourable financial situation arising within the countries representing the eurozone.

Europe’s currency, which came under selling pressure last year following the Brexit referendum, hit lows of 1.0350 versus the US dollar in December 2016, the lowest since 2002 and within striking distance of parity, before rallying close to 16 percent this year to settle around 1.2100 late last month, the highest since January 2015. The forex pair has since slipped from its September highs, leading to the minutes of the ECB’s monetary-policy meeting and the disappointment that followed thereafter. Midway through October 2017, EURUSD was trading close to 1.1800, down about 2.5 percent from the highs of last month, with key near-term resistances at 1.1900 and supports placed at 1.1700.

A delay in tapering will no doubt disappoint markets, and the European currency will be the first target, with the EURUSD pair likely to come in for a major sell-off—which could take out near-term supports and push the pair to the 1.1400 mark in quick time. On the brighter side, if Europe’s central bank sticks to its decision to begin tapering from January, they will move a step closer to some of the other major global central banks that have ended QE and have already started or are in the process of normalizing interest rates.

 

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