Continued uncertainty means the ECB continues to put the normalisation of its monetary policy on hold. Any rate hikes remain a long way off, but the 6 June meeting will see the Bank present revised economic forecasts in light of the current low inflation environment.
The European Central Bank (ECB) has entered a pause in its monetary policy normalisation, prompted by the uncertain economic outlook, a high-risk environment and a sharp fall in inflation expectations.
In this context, we do not expect any rate increases in 2019 or 2020.
The ECB must provide answers regarding the drop in inflation expectations, which have fallen to historically low levels.
The ECB remains unable to normalise its monetary policy following a deterioration in the macroeconomic outlook. The balance of risks remains tilted to the downside, and those risks – in particular persistent uncertainties relating to Brexit, Italy and, above all, global trade tensions – are difficult to quantify. Recent months have also seen a historic fall in inflation expectations .
In this context, ECB president Mario Draghi cannot hike rates. Ultimately, he is unable to do anything to normalise monetary policy beyond ending the Bank’s bond-buying programme, as he did last December. And in reality, the impact of that move is limited as the Bank has undertaken to reinvest the interest and amounts corresponding to the repayment of the securities in its maturing portfolio (some €17 billion per month to maintain its stock at almost €2.6 trillion) "over an extended period of time".
We do not expect a rate hike until 2021. Even so, the 6 June meeting could be interesting for several reasons:
The ECB will update its economic forecasts. It will be difficult for it to draw a clear picture amid inconclusive data. There is an apparent disconnect as surveys and market indicators show worsening sentiment, while hard numbers such as gross domestic product and household consumption suggest resilience. It is likely that, following its first revision in March, the ECB will continue to revise its growth and inflation prospects downwards.
We expect the Bank to address its failure to meet its price stability objective of 2% inflation in the medium term. Its analysis of the causes of this low inflation, and any plans as to how it will achieve the target will be keenly scrutinised by the markets. Inflation expectations have never been so low, reflecting investors' scepticism about the Bank's ability to meet its price stability objective, so the ECB will need to answer the perception that inflation remains the weak link in Mario Draghi's mandate.
The Bank is also expected to provide details of the terms of the third round of targeted longer-term refinancing operations (TLTRO 3) planned for September, including the borrowing rate that will be applied. The ECB has two options: to use the borrowing rate as a monetary tool, for example by matching it to the deposit rate - a way of relieving banks whose profitability is being eroded by what is effectively a 40-basis-point tax on their excess reserves; or to stick to a more restrictive acceptance of pure cash reserves in the face of uncertainty, and set a rate equal to the refinancing rate..
Finally, Mario Draghi may comment on policies that might strengthen the eurozone, in particular deepening the union of capital markets and improving budgetary coordination.
Overall, this ECB meeting should have little impact on the markets, as the meeting should endorse well anchored short-term rates, paving the way for lower rates throughout the curve. Investors are currently much more sensitive to developments concerning the hot topics such as Brexit, Italy or trade tensions.
Franck Dixmier is Global Chief Investment Officer (CIO) Fixed Income and a Managing Director with Allianz Global Investors. In this capacity, he leads and oversees the development of the firm’s Fixed Income capability and investment offering. He is a member of AllianzGI’s Investment Executive Committee and International Management Group.
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