Fears of a “dovish surprise” from the European Central Bank (ECB) are set to keep investors on their toes this week with policymakers widely expected to formally announce the scaling back of quantitative easing (QE) on the back of sustained growth in the Eurozone economy.
The latest purchasing managers' indices (PMIs), based on surveys of firms around Europe, pointed to strong growth across Europe, albeit with a slight slowdown in the expansion of output from the services sector.
Germany's composite indicator, measuring services and manufacturing, fell from a reading of 57.7 to 56.9, according to data firm IHS Markit. That contributed to a lower reading across the Eurozone, where the widely followed indicator fell from 56.7 to 55.9.
However, the reading remained well above the 50 mark indicating growth, setting the scene for the ECB to go ahead with its plan to start tightening monetary policy.
The central bank will announce its latest decision at 12:45pm on Thursday, followed by a press conference at 1:30pm led by ECB president Mario Draghi.
Economists expect a nine-month extension of the QE bond-buying programme at €30bn per month on average, according to a Bloomberg survey. The ECB is currently buying €60bn per month in an attempt to push money out into the broader economy.
The ECB has multiple options to taper the purchases, with economists set to scrutinise closely the path chosen as the central bank tries to begin normalising monetary policy, tightening the supply of money.
The desire to normalise monetary policy has gained a stronger impetus for the ECB as concerns over a scarcity of suitable assets have risen. However, the ECB is still waiting for signs of price rises which would normally justify tighter monetary policy.
Mike Bell, global market strategist, JP Morgan Asset Management, said: “The ECB is caught between a healthy growth backdrop and still low core inflation, despite the fact that near-term deflation risks have significantly reduced.”
Markets would interpret a longer duration for the programme or a smaller reduction in purchases as a sign of less confidence in the European economy.
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A dovish statement from Draghi could help temper the strength of the euro, which has acted to dampen inflation in the Eurozone below the ECB’s two per cent target.
Florian Hense, an economist at Berenberg Bank, said market expectations for tightening may be too quick, warning of the possibility of a “dovish surprise.”
However, a shorter duration and consequent earlier reassessment could give the ECB “more policy space and flexibility”, according to Robert Bergqvist, chief economist at Nordic bank SEB.
Draghi could also emphasise the distance of the next hike in interest rates, a dovish signal, in an attempt to temper the market reaction to quantitative tightening.