ECB is preparing to change its tone on monetary policy

The European Central Bank (ECB) is prepping for its latest rate decision Thursday, but while no market watchers are expecting a change in its extraordinary monetary stimulus there could be a modification on the language for the economic risks the bank is facing.

President Mario Draghi and his team at the European Central Bank are treading a fine line: while economic data suggests that the euro zone economy is doing much better than expected, inflation is still not close to their target of below but close to 2 percent.

"However, we would still expect some soft exit expectations management, for example, talking up economic growth and tasking the internal committees to consider the options for forward guidance, deposit rate and QE (quantitative easing)."

Economic growth in the euro zone was almost twice as fast as it was in the U.S. in the first quarter of 2017, raising the question whether more stimulus was required as the recovery appears to be self-sustaining.

"The upswing is becoming increasingly solid, and continues to broaden across sectors and countries, " Peter Praet, the ECB's chief economist, said in a speech May 24.

Inflation in the euro zone slipped to 1.4 percent in May, its lowest reading since December, and also more than expected. So-called core inflation - stripped of energy and unprocessed food prices - also fell to 1 percent from 1.2 percent. This is clearly supporting the doves in the Governing Council who call for longer than shorter stimulus.

At the upcoming meeting in Tallinn, Estonia, the ECB will also present a new round of staff projections for inflation and growth.

"There is some uncertainty over how the new euro system staff projections could change," writes Anatoli Annenkov of Societe Generale in a note.

"While the economy is doing rather well, the Governing Council has been clear that it considers the previous wage assumptions as high, given the uncertainty over the slack in the labor market. With lower wage growth and a slightly stronger exchange rate assumption, there is likely room to reduce the 2019 inflation forecast somewhat."

This is why the ECB currently is caught between a rock and a hard place. With inflation not credibly close to its target, the ECB cannot start the real exit process even though calls for an end are getting louder and louder.

When it comes to the real "taper", those who were expecting action this year, are bound to be disappointed.

"We expect the ECB to continue buying assets into 2018," said Jack Allen of Capital Economics, in a note.

"We think that it will spell out in September its plan to taper QE. This seems most likely to mean reducing purchases by 10 billion euros ($11.26 billion) each month, starting in January 2018. This would bring them to an end by June."

Source: Bloomberg Pro Terminal

Jr Trader Petar Milanov

Read more:

• Central Bank monetary policy in 2018 – Where to expect changes
• Varchev Finance: Trading day in one post – 17.10.2017
• The capital rotation between sectors, a good opportunity for bulls
• Chinese debt – the “new” problem facing global markets
• Markets in the US are expected to open with positive moods