From BoA / Merrill Lynch on what to expect from the European Central Bank today and further out. A good, if long, piece:

(bolding is mine)

  • Our sentiment is that there is a consensus at the moment at the Governing Council to leave the stance and communication largely unchanged for now, even if we think that this consensus does not extend on which decisions to make, when the time comes.
  • This means that while we don't expect any hard decision or any significant communication surprise ... we also believe that the policy conversation could be quite fierce from June onward
  • We continue to think that in the face of a still subdued inflation outlook, prudence will prevail and that the ECB will opt for small changes to forward guidance in June, a very slow pace of tapering in 2018 and no policy rate hike before well into next year, if at all
  • Still, the hawks - and some centrists - in the Governing Council are clearly tired of extraordinary measures, so that the market could start pricing a more aggressive stance, (over)reacting to hawkish noises, in the second half of this year
  • In our opinion, most Governing Council members in March were not expecting their tiny move on forward guidance to trigger such a massive market reaction. ‎After engaging in concerted damage mitigation in the two weeks before the Easter break, we think they will be looking for some peace and quiet at the April meeting. We note in particular that even some hawkish hardliners such as ‎Governing Council Hansson have recently stated that the ECB is "looking at the data" which suggests that even this block of the Council is not after an immediate policy discussion.
  • board member Coeure was keen to say that the ECB is "very very serious about forward guidance", which does not sound like having another go at this essential part of their communication is on their wish list.

There are we think several reasons behind this truce:

  • First, the data provides fodder for hawks - who will focus on strong surveys pointing a swift pace of output gap reduction - and doves - who continue to worry about weak core inflation and hard data which do not fully live up to the surveys' promise.
  • Second, the March episode, with the market hastily pricing depo rate hikes, will remind Council members that moving market expectations is more an art than a science, with significant risks of overreaction.
  • Third, the political context - the ECB meets between the two rounds of the French presidential elections - goes against making big moves.

Still, the debate is going on, underground. We think Benoit Coeure - who in his role of "market man" at the board is probably quite sensitive to the need to provide investors with sufficient visibility - is trying to gently move the communication towards a very slow "Exit strategy". ‎

  • He stated that the balance of risks to growth is now neutral - the council statement kept it "tilted to the downside" last month.
  • He's been very candid on the direction of travel for the ECB since December - e.g. in his speech at the end of last year about the need for governments to prepare for higher interest rates - ‎so he is probably keen to prepare the market for a gradual removal of QE.
  • Peter Praet - the chief economist, i.e. more focused on macro developments - for his part continues to insist on the weakness in inflation and this week stuck to the negative balance of risk.
  • More profoundly - those are limited divergences we think - hawks are probably still ready to argue for a swift decommissioning of the ECB's unconventional arsenal as soon as the political situation allows it.

In our baseline, the statement (today) does not change

  • In June the assessment of the balance of risks would move to neutral, while the most dovish part of the forward guidance - the notion that rates could fall further - would be removed (a cheap bone to throw to the hawks in our opinion).
  • Then in September the Council would start preparing the market to slow tapering in 2018 (e.g. going first at EUR 40bn for 6 months before gradually moving to zero by the end of 18) while the forward guidance on rates would be more thoroughly changed - dropping the notion that there would be a long delay before the end of QE and the first hikes, while opening the door to some "technical tweaks" to the depo rate which would not materialize before well into next year.
  • In our baseline, the ECB would still be a net purchaser of securities at the end of 2018 (to be clear, would stop by December 2018). It seems to us that the market tends to focus on a hawkish alternative to this, with a fast pace of tapering and quicker rates. We agree that's what the noises from the hawks and centrists suggest.‎ But we also continue to believe that core inflation will disappoint the ECB. That's what motivates our belief in a very, very slow and considered exit.

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