For the ECB, it’s taper-pause-hike

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There has been confusion in financial markets about the order in which the ECB would taper and ultimately remove monetary policy accommodation: would the European central bank gradually reduce the asset purchases under its quantitative easing (QE) programme and only then raise its interest rates or might rates go up before there is any tapering?

Yes to ECB action soon on some points…

The eurozone economy now looks strong enough to justify central bank action: the unemployment rate has improved and retail sales growth has come in stronger than expected at 1.8% YoY in volume terms. However, as reported, core inflation has actually slipped to just 0.6%. So, there is work to be done by the ECB to lift inflation. Wage growth, also identified by the ECB as a precondition for action, has so far hardly materialised.

…but no convincing evidence yet

At the March meeting of the ECB council, there was no discussion of the merits of an alternative strategy to exit QE, such as one including an early increase in the (now negative) deposit rate. But at a recent ECB watchers conference, president Draghi and chief economist Peter Praet delivered two key messages. First, an insistence that monetary policy must remain loose because there is no convincing evidence of a pickup in underlying inflation and, second, that the council is committed to executing the taper-pause-hike exit strategy when the time comes.

French elections: another twist and another source of nervousness

On the political front in Europe, the latest twist in the run-up to the French presidential elections is the rise of the far-left’s Melenchon at the expense of the socialist Hamon. Indeed, the latest polls suggest Melenchon may have pushed the centre-right candidate Fillon into fourth place.

The rise of Melenchon reminds us that euroscepticism is more widespread across much of Europe than many believe and that a run-off of Melenchon and the Front National’s Le Pen would certainly give financial markets palpitations. However, polls still forecast the centrist Macron to make it through to the second round and then win decisively. He should benefit from tactical voting from across the centre if Melenchon looks like becoming a serious threat.

The latest developments in the polls for the French presidential elections led to spread widening on French, Italian and Spanish bonds, although we see this as temporary.

Published on 12 April 2017

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