According to today’s flash estimate for May, eurozone inflation fell to 1.4% (from 1.9% the previous month), i.a. due to the dropping out of the Easter effect. Annual core inflation (excluding energy and unprocessed foods) fell to 1%. We see headline inflation hovering around 1.5% over the rest of the year. We have trimmed our average inflation forecast for 2017 by one-tenth to 1.6%. Core inflation is likely to edge up slightly from its current level, narrowing the gap to the headline rate.
In the ECB projections due to be released next week we are not expecting any major changes with regard to either eurozone inflation or economic growth. But the recent thoroughly upbeat economic data should be reason enough for the ECB to adjust its forward guidance. It is likely to drop its loosening bias with regard to both key rates as well as QE. As nobody is expecting a rate cut or an increase in the monthly volume of bond purchases any longer, notable market reactions are unlikely. In our view, the adjustment to forward guidance would be the first step to then, from September, talking about a reduction in bond purchases – as things stand we are penciling in a reduction from EUR 60bn to 40bn a month early next year.
In terms of its mandate, the ECB is currently not under any pressure to act, with inflation rates slightly below its target and no grave inflation risks in sight. However, the ultra-loose monetary policy sits uncomfortably with the healthy economic backdrop. Although the ECB highlights the slack on eurozone labor markets in its latest monthly report, the situation is improving steadily, as today’s jobless figures show. In April the eurozone unemployment rate fell to its lowest level since March 2009. Our current forecast that tapering will be concluded by the middle of next year, and that the negative deposit rate will be nudged up slightly in the second half of 2018 followed by an initial hike in the main refinancing rate in early 2019 means that monetary policy is set to remain loose for a long while yet.