It's Too Early for ECB's Mario Draghi to Talk Seriously About Monetary Tightening

 | Aug 31, 2017 | 9:00 AM EDT
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Next Thursday is a day a lot of market participants are anticipating (or dreading): the European Central Bank's first monetary policy meeting after the summer will take place. But those who believe this will bring clarity on the ECB's plans for "quantitative tightening" -- the opposite of quantitative easing, where the central bank buys bonds to lower interest rates -- may well be disappointed.

Yes, the central bank's Governing Council will probably discuss monetary tightening, in one way or another. After all, German elections will take place on Sept. 24, and although Chancellor Angela Merkel is ahead, the unpredictable nature of public opinion requires at least a nod to the Germans' perpetual worries about inflation.

But for once, luck seems to be on the ECB's side (for now, at least). Inflation is tame -- it came in at 1.5% for August, below its 2% target, while core inflation, which strips out volatile food and energy prices, was flat at 1.2%.

The euro has strengthened by 14% to the U.S. dollar year to date, but instead of causing pain, this seems to have contributed to a strengthening of the eurozone economy. That's because it helps keep prices low at a time when the euro area is relying more and more on domestic consumption, rather than exports, for growth.

The single European currency has not risen only against the greenback. It has strengthened against the British pound and the Swiss franc, too, "so much so that the trade-weighted euro has risen back to mid-2014 levels," economists at Societe Generale pointed out in recent research.

The recovery is spreading, too, as data released on Wednesday by the European Commission on economic sentiment in the eurozone show. In August, the economic sentiment indicator, which encompasses both business and consumer confidence, jumped to its highest level since July 2007, while economists had expected it to remain stable.

The sharpest increase in economic sentiment among the eurozone's biggest economies was in Italy, up 3.6 points, followed by France (+1.7) and Spain (+1.4). Germany and the Netherlands, by contrast, reported slight decreases in economic sentiment.

The data on price expectations suggest the ECB has no reason to rush into a plan to start tightening monetary policy: Consumers' price expectations remained broadly unchanged, whereas in the retail sector and in construction selling price expectations fell. They were stable in services and increased only in the industrial sector.

Last but not least, how about expectations for the future of the eurozone? The German Constitutional Court referred the ECB's QE program to the European Court of Justice to hear whether the EU's highest court believes QE is in line with the ECB's statute, which forbids it from financing member states' debt. This should be quite worrying for investors.

But the ECB seems to be in a sweet spot here, too: the Sentix Institute's euro breakup index, released last Monday, shows that "investors look at the eurozone with astonishing serenity," in the words of Sentix Institute managing director Manfred Huebner. The overall index fell to 8.0%, which is only just above its all-time low reached in July 2014.

Judging by the data so far, market participants should perhaps expect ECB President Mario Draghi to offer some verbal intervention to try to slow the strengthening of the euro, but nothing too serious. As for quantitative tightening, expect some vague comments, but no more than that. It is still too early.

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