Inflation and exchange rate: Favorable constellation for tapering

Today’s inflation numbers are moving slowly in the right direction. Although next week the ECB is likely to extend its monthly bond purchases of EUR 80bn for a few months more, we see plenty of reasons for it to simultaneously announce a reduction in the purchase volume for the time thereafter.

According to today’s flash estimate for November, inflation in the eurozone edged up slightly to 0.6% (October 0.5%). At 0.8% on a year earlier, core inflation (excluding energy and unprocessed foods) remained subdued. Although these numbers are still far removed from the ECB’s 2% benchmark, the trend is right and is set to continue. On average next year we see eurozone inflation at around 1.5%. In addition, since the US election market-based inflation expectations have moved up sharply on both sides of the pond.

Not least due to the expectation of diverging Fed and ECB monetary policy, the euro has fallen against the dollar. This helps both the economy as well as inflation in the eurozone. In our view the time is (more than) ripe to lower the curtain on the ECB’s ultra-loose monetary policy. Although the ECB will probably not decide next week to rein in its bond purchases from April, it should announce in conjunction with the extension of the EUR 80bn purchase volume that it plans to taper from the third or fourth quarter 2017 (barring unforeseeable shocks, of course). This would help prime markets for the exit from extremely loose monetary policy and avoid excessive reactions on the bond market in particular.

However, the ECB will be keen to maintain as much flexibility as possible in terms of the modalities of tapering, not least given the important elections looming in Europe which will only add to the prevailing economic uncertainty. This means that, with regard to the exact scale and specific timing of the gradual reduction in bond purchases, the ECB is unlikely to commit itself long in advance.


Claudia Broyer

Allianz SE
Phone +49.69.24431-3667

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