Divyang Shah
IFR Senior Strategist
Right now market expectations are split between a rate cut happening at this week’s meeting and a cut in December. A December cut would also help to discourage expectations that the QE-type easing is around the corner, and help the ECB to portray that the data was not a complete surprise.
The staff projections could be used to explain that low inflation is temporary and that further easing is warranted because the ECB sees inflation staying low rather than deflation.
The ECB will likely use both the post-meeting statement as well as Draghi’s press conference this week (Nov 7) to hammer home the message over the inflation outlook.
As it happens, a rate cut might not happen this year as the ECB appears undecided and lacks a consensus as to what to do with the deposit rate.
So the ECB is likely to make comforting sounds sufficiently dovish on deflation to keep the markets biased toward a December cut. It will also hope to create further downside momentum on the EUR.
The strong EUR has contributed to the eurozone’s disinflation story.
At the very least the ECB will be satisfied that the brakes have been applied to the EUR rally. The question is whether EUR weakness can be sustained in the face of continued balance sheet expansion by the Fed as it delays tapering, and the ECB’s shrinking balance sheet as banks’ excess liquidity continues to fall.
