The eurozone economy remains on a moderate upward path and in the coming months inflation will climb appreciably. Although this is largely due to the rebound in oil prices, it is also likely to shore up inflation expectations further. At the last Governing Council meeting of the year in December the ECB will face a difficult choice. In macroeconomic terms, given the stable economic picture, everything would argue for tapering to start in April 2017. Inflation is moving in the right direction, deflation fears on the financial markets have been banished and, given the inherent delayed effects, the ECB’s ultra-loose monetary policy will continue having an impact for a while yet.
The challenge for the ECB’s communication will be to avoid spooking the bond markets with wild jumps in yields. The financial markets are still assuming that the ECB will stick to its ultra-loose stance, any indication of a correction in this policy could spark reactions, particularly as the US Fed is likely to continue its policy of gradual rate hikes. In this situation the ECB will wish to preserve flexibility with regard to the modalities/speed of tapering and tie its policy to the incoming data. However, flexibility should be understood symmetrically. If the economic data are substantially worse than in the current and in the new December projections, monthly bond purchases should be reduced only gingerly, should they turn out better then a swift reduction is called for. As things stand, it should be possible to end bond purchases, which are causing severe price distortions on the markets, by the close of 2017.
ECB representatives have indicated that the exit from unconventional measures will be completed first before moves towards ending the zero interest rate policy can be expected. However, we think it desirable to scrap the negative deposit rate as early as possible. The penalty rates are not having the desired result, rather they are a major strain on banks’ profitability and capital formation that are of such importance for the stability of the financial sector.