ECB Upgrades Eurozone Growth Forecasts but Euro Drops after Inflation Disappointment

The European central bank kept monetary policy unchanged but substantially revised up economic growth projections at its policy meeting on Thursday. 

The Euro fell Thursday after the European Central Bank said inflation is likely to remain below its 2% target until after end of the forecast period and left markets guessing as to when it might eventually bring its quantitative easing program to a close.

Needless to say, the ECB kept all aspects of Eurozone monetary policy unchanged following its December meeting even though, on a brighter note, it revised up forecasts for economic growth - especially in 2018.

In truth, few analysts really believed the ECB would firm up an end-date for its stimulus reduction program, particularly because it hasn't yet started the reduction in bond buying announced back in November.

Forecasts showing inflation still running below the central bank’s target in 2020 were probably what hurt the common currency the most as the market has no chance of seeing an interest rate rise from the ECB until consumer prices can sustain a return to 2%.

The Euro-to-Dollar rate was quoted 0.35% lower at 1.1794 after the London close while the Euro-to-Pound was down 0.57% at 0.8776.

Eurozone economic growth is forecast to come in around 2.4% for 2017, 2.3% in 2018 and at 1.9% in 2019 - all numbers that have been upgraded since the last round of projections. 2020 will see the economy expand by 1.7% in 2020, according to the ECB.

Inflation forecasts were revised up for 2018, to 1.4% from 1.2%, but prices are seen growing by just 1.7% in 2020. The latter forecast is disappointing because it puts inflation below the ECB's 2.0% target for as far as the eye can see.

The ECB reiterated its commentary on quantitative easing from the last meeting, saying it will cut the rate of bond purchases from €60bn per month to €30bn in January but continue the program until September 2018 “or beyond”.

All interest rates were held unchanged, with the overnight lending facility still at 0.0%, the marginal lending facility at 0.25% and deposit facility still negative at 0.40%.

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Analyst Views:

Hann-Ju Ho, Senior Economist, Lloyds Banking Group

"It (the ECB) also left its asset purchase programme open-ended, repeating that “we stand ready to increase the asset purchase programme in terms of size and/or duration.”

"President Mario Draghi sounded more upbeat about the economic outlook and expressed greater confidence about inflation returning to the ‘close to, but below, 2%’ target over the medium term. He noted a “strong pace of economic expansion and a significant improvement in the growth outlook."

"Looking ahead, we expect the ECB to wind down its asset purchase programme after next September, possibly communicating its intentions around July."

Victoria Clark, Analyst, Investec Bank

"The updated Eurosystem staff macroeconomic projections provided the greatest source of interest today. Here the ECB upgraded its 2017 growth forecast by 0.2ppts to 2.4%, which would be the firmest Euro area growth pace since 2007. 2018 growth projections received a 0.5ppt upgrade to 2.3% and growth was seen just a shade below 2% in 2019."

"By running a story in which growth momentum solidifies but the ECB remains to be convinced on the sustained nature of inflation’s recovery, the GC can keep markets guessing and move into a more comfortable waiting period through 2018."

Marco Valli, Head of Macro Research, UniCredit Bank

"The key theme of the GC discussion was the increased confidence that a faster narrowing of the output gap will eventually push underlying inflation higher."

"But we note that, despite clearly stronger GDP forecasts, the ECB’s own projections for core inflation have actually been revised further down throughout next year, de facto delaying the time of a clearer acceleration to 2019 and 2020." 

Jan von Gerich, Analyst, Nordea Markets

"Greater confidence naturally also leaves more room for a disappointment. We continue to expect obstacles in the way towards higher core inflation, and see another 6-month extension in the asset purchase programme after September 2018, with a decreased monthly volume of EUR 15bn."

Brendan Lardner, Portfolio Manager, State Street Global Advisors

"While Draghi noted the ongoing strength of the Euro area recovery, which is increasing the ECB’s optimism that inflation will eventually follow, caution was still expressed about the low underlying level of inflation and hence the need for continued policy support."

"This is supported by the relatively strong growth forecasts released today while the inflation forecasts, while improved in 2018, still show no sign of a meaningful pick up, with the new forecast for 2020 inflation coming in at 1.7%."

"The ECB’s confidence is rising, but not sufficiently yet to announce any changes to the purchase programme."

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