ECB Monetary Meeting: A Key Event To Watch

The European Central Bank is gathering next week to conduct a new monetary policy meeting. While investors always keep an eye on these events, in recent years there hasn’t been interesting news to weigh in. But so it seems that is about to change.

The European regulator has maintained a soft stance on monetary policy, providing continuous stimulus to the bloc’s economy with its massive bond-buying programme.

ECB President Mario Draghi has defended the need to keep stimulus running in many different occasions, but recent economic data makes it clear that the EU has recovered well enough to justify policy changes, especially concerning stimulus.

Earlier this year, the European Central Bank opted for a modest path as ongoing political crisis popped out in Germany, Italy and Spain. All three situations were seen as potential threats to the unity of the European Community and sources of market instability.

On Wednesday, ECB Chief Economist Peter Praet took investors by surprise with an unexpected message: the bank could soon cut its €30 billion-a-month bond-buying programme.

The ECB’s signal comes at a sensitive time in European politics. Italy’s new populist government has spooked investors with plans to allow more government spending to loosen the rules governing the currency union, which could trigger a clash with other governments, notably Germany’s.

Speaking in Berlin, Mr. Praet said the ECB was increasingly confident that inflation would soon rise toward the bank’s target of just below 2%—a target it has missed for years.

“Next week, the governing council will have to assess whether progress so far has been sufficient to warrant a gradual unwinding of our net [bond] purchases,” Mr. Praet said.

The comments surprised investors, many of whom hadn’t expected a decision on the future of ECB stimulus until July.

Mr. Praet’s words were the last scheduled remarks by an ECB executive-board member before a blackout period ahead of the bank’s policy meeting in Riga, Latvia, on Wednesday and Thursday next week.

The euro jumped almost half a cent against the dollar after Mr. Praet’s comments were published, while eurozone government bonds sank. Italian bonds were hit particularly hard as investors predicted the exit of a giant buyer.

Mr. Praet’s comments are significant because the Belgian official is responsible for framing the ECB’s policies and is generally considered one of the “doves” on the bank’s rate-setting committee, meaning he emphasizes growth and employment over low inflation.

Senior ECB officials had signaled recently they might need more time to assess the reasons for a recent slowdown in the bloc’s economy. They have also highlighted mounting threats from trade protectionism, which could hit the export-focused eurozone economy hard.

Mr. Praet’s “remarkable” speech “provides further evidence that there is a growing majority within the governing council favoring an end of [bond purchases] by the end of the year,” said Carsten Brzeski, an economist with ING in Frankfurt.

Other top ECB officials—notably German central bank President Jens Weidmann and executive-board member Sabine Lautenschläger —have signaled that the bank should end its bond purchases this year. The purchases, known as quantitative easing, are currently due to run at €30 billion a month at least through September.

In a video message delivered in Berlin on Wednesday, Mr. Weidmann said he found it “plausible” that QE would end in 2018.

ECB officials have indicated for months that they are preparing to phase out QE as the region’s economy accelerates and unemployment falls.

However, recent data and business surveys suggested that the economy has slowed this year. ECB officials attribute that partly to a natural easing of growth from a very fast pace, as well as temporary factors such as poor weather and an outbreak of influenza.

Still, underlying inflation remains weak and ECB officials have said they want to see further economic data before making a decision. The bank will next week publish its quarterly forecasts for growth and inflation, which it often uses as the basis for policy decisions.

“It seems that the majority of the ECB considers the series of weaker hard macro data as a soft patch rather than the start of a downswing of the eurozone recovery,” Mr. Brzeski said.

The Italian government’s spending plans, coupled with concerns Italy might ultimately leave the eurozone, have pushed up borrowing costs for the nation’s highly-indebted government, as well as those of other southern European countries. Any crisis in Italy could undercut eurozone growth and potentially require fresh stimulus from Frankfurt.

However, analysts suggested the ECB might want to keep its policy plans on track precisely because of the crisis in Italy.

“The ECB will be very careful not to be seen to hurt or help the Italian government,” said Marcel Fratzscher, president of German economic think tank DIW.

Some ECB officials—notably Mr. Weidmann—have long warned the bank could come under pressure to extend its bond purchases to prevent a jump in borrowing costs for the region’s highly indebted governments, which could undermine the economic recovery.

“Closing the QE chapter a week after populists come to power in Rome signals the ECB’s unwillingness to allow its monetary policy to be ‘taken hostage’,” analysts at Bank of America Merrill Lynch said in a note.

FortFS