The ECB managed to deliver both a hawkish shift, and maintain a dovish stance, at its meeting this week. Modifying its opening statement in a way that clearly indicated quantitative easing was on its way out, ECB President Mario Draghi then delivered a dovish press conference, emphasising the continued need for persistence and patience with accommodative monetary policy. In some respects this has become a vintage ‘ECB play’, or perhaps more accurately, a vintage ‘Draghi play’.
This combination of dovish hawkishness is symptomatic of the several key challenges the ECB faces, the most apparent being the lack of inflationary pressures across the eurozone as a whole. However, while pan?eurozone inflation may remain worryingly depressed, some parts of the euro area, chiefly Germany, look increasingly at risk of overheating.
Balancing the increasingly hawkish chorus from the more overheated parts of the eurozone with the clear need for accommodative policy in other more southerly parts, requires a deft touch. Deleting the comment on increasing quantitative easing (QE) should conditions worsen, represents both a sop to the more hawkish members of the governing council who see strong arguments for more normal monetary policy, while also being a cold necessity, given the increasing scarcity of certain government bonds for the ECB to buy. By shifting the emphasis to forward rates guidance (and by implication low rates), Draghi has been able to portray the ECB as simultaneously taking away accommodation with one hand while maintaining it with the other.
For investors, the message is one of ‘steady as she goes’. The ECB was expected to downgrade QE for the reasons stated above. Barring some intraday volatility, neither the exchange rate nor the bond markets show any signs of a significant pivot in ECB behaviour.
Draghi’s ability to manage a message of gradually reducing policy stimulus but with a firmly dovish core message is likely to remain a key driver of the relative calm in eurozone bond markets. For 2018, this probably means volatility in the euro area will remain lower than in other jurisdictions. As we progress and Draghi’s term draws nearer to its end, maintaining the ECB’s dovish/hawkish balancing act will be increasingly challenging.
