30.06 Weekly Viewpoint : The markets’ reaction to Draghi’s speech in Sintra was probably excessive

The markets’ reaction to Draghi’s speech in Sintra was probably excessive, but understandable: the end of the “great easing” is nearing, in Europe too. The string of positive surprises from macro data suggests that the ECB may have to adjust its monetary policy stance sooner than expected…..

Draghi’s speech in Sintra on 27 June triggered a sharp correction on the bond markets and drove up the euro’s exchange rate. A similar effect was reaped in the United Kingdom by Carney’s statement that a lending rate hike may no longer be such a distant prospect. The movement then spread to all the main European stock markets. Tension on the markets was generated by Draghi’s reference to the appropriateness of “adjusting of monetary policy parameters”, because “as the economy continues to recover, a constant policy stance will become more accommodative”. In the following days, Reuters quoted “sources close to Draghi” as saying that the market was wrong to ignore the caveats contained in his speech, ultimately missing the fundamental message that was patience , and certainly not any imminent moves. Draghi’s intention was to prepare markets to the announcement, on occasion of the autumn meetings, of possible changes to the asset purchase programme in 2018; changes which should already have been priced into the consensus scenario. Yet, it is true that the June introductory statement made no explicit reference to adjustments of monetary policy parameters. 

The reaction of the markets confirms that the communication of central banks, while improved and more effective, is always tricky in “epochal” monetary policy reversal phases, as the present one, in which the “great easing” and era of cheap money is ending. However, tensions on the markets are also being fuelled by economic data. The IFO survey index soared to new all-time highs. In Italy as well, business confidence beat expectations. The Bank of Spain signalled that GDP may have grown by 0.9% q/q in the spring months, beating the winter performance. Lastly, on Thursday the European Commission’s Economic Sentiment Index put its seal on the previous days’ positive surprises by rising by two points to 111.1, its highest level in almost 10 years, leaving little doubt on the intensity of the recovery: euro area GDP is growing at a faster pace than in Q1, supported by recovering exports and by more upbeat retail sales and construction activity. Businesses remain optimistic on the trend of demand over the next few months and on job creation. Confidence surveys seem to point to GDP growth of at least 0.7% q/q in the spring months. However, we remain cautious and confirm our growth forecast of 0.6% q/q, in part due to the fact that the quarterly trend may have been held back by calendar effects (April had fewer workdays compared to March and to last year). Furthermore, as also estimated by the Commission, at like-for-like levels of the ESI and other confidence indices, GDP growth rates are now weaker than they were before 2008. For the time being, we confirm our forecast of average annual GDP growth of 2.0% for 2017, but we signal that the balance of risks is now skewed to the upside.

As growth data beat expectations, inflation data also surprised on the upside. German inflation rose by 0.1 to 1.5%, against expectations for a decline, driven upwards once again by the prices of recreation services. In the euro area as a whole, inflation dropped by one tenth, whereas core inflation rose to 1.2% from 1.0%. This could be a temporary movement, as was the case between March and April (when prices in the recreational services sector were also the main driver), although the more frequent recurrence of price spikes may signal the existence of some upside pressure on domestic prices. The inflation trend will be distorted by statistical effects in the coming months (favourable until the end of the summer, negative starting in the autumn). As the recovery consolidates at a faster and more intense pace than expected, risks to the inflation trend also decline, and will probably make the need to adjust monetary policy parameters less cautiously. Unless the self-induced tightening of financial conditions does not become excessive.

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