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ECB meeting preview: will the ECB remain patient despite rising inflation?


ArvinIG

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The ECB have remained steadfast in their view that inflation is ‘transitory’, but will the bank remain an outlier with their patient approach to elevated inflation?

ECB
Source: Bloomberg
 
 

ECB meeting: the basics

The forthcoming European Central Bank (ECB) meeting will take place on Thursday 28 October 2021. The initial monetary policy decision will be announced at 12.45pm BST, with the press conference getting underway at 1.30 pm.

 

Will the ECB continue to tow a dovish line despite rising inflation?

The past six months has seen inflation soar throughout the globe, with central banks showing varying degrees of anxiety over that seemingly incessant rise in the prices. In Europe, we are seeing a notable divergence in outlook, with the Bank of England preparing to raise rates, while the ECB has reiterated their belief that this period of above-target inflation is transitory. Nonetheless, EUR/GBP has certainly been under pressure as traders consider the widening gap that could develop between UK and eurozone rates. The chart below highlights how eurozone and UK inflation has been relatively similar for the most part, with US prices providing the outlier at an impressive 5.4%.

 

CPI inflation rates compared
Source: Refinitiv Datastream


Interestingly, this is isn’t expected to go anywhere according to eurozone households, with one-year inflation expectations at the highest level in almost a decade.

Euro area household one-year inflation expectations
Source: Refinitiv Datastream


Crucially, core inflation does still remain below the 2% target (1.9%), providing some support for Lagarde to reiterate the official line that pricing pressures are should not necessarily bring about a tightening phase right now. Instead, it is clear that much of the growth in pricing revolves around energy costs, which are largely out of the control of the ECB.

Euro area HICP
Source: Refinitiv Datastream


From an economic perspective, we have seen a significant rise in pressures for the manufacturing sector. Rising input prices, delivery delays, and hiring issues have brought expectations that we could see the sector under pressure in the months ahead. From a full purchasing managers index (PMI) perspective, we can see those problems in the manufacturing sector dragging the composite reading lower. This image also highlights how growth is likely to take a hit if we continue to see weakness in the figures for the coming months.

IHS Markit Eurozone PMI and GDP
Source: IHS Markit, Eurostat

What to expect from the ECB

December sees new inflation and growth forecasts, meaning that there is a good chance we will see the ECB hold off on a decision to extend the Pandemic Emergency Purchase Programme(PEPP) until they get greater clarity on that front. There is an argument that the central bank could trim back their asset purchase programme in response to above-target inflation. However, the fact is that the pressure on manufacturing coupled with the negative effects of rising fuel prices could quell the desire to pull back too soon.

With that in mind, traders should keep a keen eye out for discussions over whether to extend the PEPP beyond March 2022, and how to trim down the asset purchases as the economy shows signs of improvements. While many central banks are looking to tighten monetary policy, there is a good chance that the ECB implements a third asset purchase programme to ensure they remain accommodative.

EUR/GBP expected to remain under pressure

EUR/GBP has been on the back foot over the course of the past month, with expectations of a BoE rate risk coming in start contrast to predictions that such a move could come in late-2023 for the ECB. A hawkish tilt from the ECB could help alleviate that downward pressure. However, a decision to maintain the dovish stance with a confidence behind the ‘transitory’ inflation message could drive another move lower for the pair.

The four-hour chart highlights how the pair is on the rise towards the meeting. A break-up through the £0.8476 swing low signals the potential for a wider upward retracement for the pair. Until that level is broken, the short-term move higher looks like another potential retracement set within a downtrend.

EUR/GBP chart
Source: ProRealTime
 
 Joshua Mahony | Senior Market Analyst, London
28 October 2021

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