Unthinkable for ECB to Consider Tapering

It’s been a slow start to trading in Europe on Thursday and US futures are currently trading relatively flat, as markets pause ahead of today’s ECB monetary policy decision which will likely bring a healthy dose of volatility.

The ECB is expected to announce an extension to its quantitative easing program, beyond the current March 2017 expiry, as it looks to continue its mission of returning inflation to below but close to 2%. It’s been four years since inflation was last at 2% and five years since core inflation hit these levels so the ECB has failed miserably in regards to its mandate for some time, despite its best efforts.

Eurozone CPI

Source – Chart of eurozone CPI from MarketPulse Economic Calendar

EUR/USD – Euro Punches Above 1.08, Markets Await ECB Rate and QE Decisions

With inflation still well below target and the eurozone economy recovering gradually but with enormous amounts of slack still remaining, it seems unthinkable that the ECB would consider tapering its asset purchases today in order to deal with the problem of asset availability. I think it’s more likely and far more sensible for it to alter the structure of the program slightly in order to accommodate more purchases. Of course, for this to happen Draghi will have to get policy makers on board which is clearly not a straightforward task or we wouldn’t be in this position three months before it expires.

Whatever option the ECB goes for – be it increasing the proportion of bonds it can hold above the current 33% level, abandoning the need for yields to be above the -0.4% deposit rate, reducing the deposit rate or something else – it’s important that the central bank isn’t seen to be becoming less accommodative. Any form of tapering without an appropriate replacement, or even a hint at an intention to do so in the near future, could trigger a sharp rally in the euro and European yields.

Risk on

A reduction in stimulus could be seen by markets as the central bank conceding defeat in its mission to return inflation close to 2% or an inability of President Mario Draghi to still rally the troops in support of the kind of stimulus the euro area requires. Either way, markets will likely respond very negatively to such an action which could set the eurozone back heading into a huge year for the region.

Economic Calendar

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Craig Erlam

Craig Erlam

Senior Currency Analyst at OANDA
Based in London, England, Craig Erlam joined OANDA in 2015 as a Market Analyst. With more than five years' experience as a financial market analyst and trader, he focuses on both fundamental and technical analysis while conducting macroeconomic commentary. He has been published by The Financial Times, Reuters, the Wall Street Journal and The Telegraph, and he also appears regularly as a guest commentator on networks including Sky News, Bloomberg, CNBC and BBC. Craig holds a full membership to the Society of Technical Analysts and he is recognized as a Certified Financial Technician by the International Federation of Technical Analysts.