ECB Preview: Rate Decision due at 1245BST/0645CDT and Press Conference at 1330BST/0730CDT

• All rates and the current pace of asset purchases are expected to be left unchanged.
• The ECB is expected to tweak its forward guidance by categorising its growth risks as balanced. There is also a chance it may adjust guidance on rates and asset purchases.
• Staff will update macroeconomic projections; any shift in forward guidance will be contingent on its views on how inflation will evolve going forward.
• Draghi may strike a cautious tone in his press conference to temper hawkish expectations, especially given the challenges in reaching the central bank’s inflation objectives.
• Any changes to guidance will lead to questions about how the ECB intends to exit loose policy.

RATE/ASSET PURCHASE EXPECTATIONS

• DEPOSIT RATE: Forecast to remain unchanged at -0.40%. The rate was last adjusted in March 2016, when it was cut by 10bps.
• REFI RATE: Forecast to remain unchanged at 0.00%. The rate was last adjusted in March 2016, when it was cut by 5bps.
• MARGINAL RATE: Forecast to remain unchanged at 0.25%. The rate was last adjusted in March 2016, when it was cut by 5bps.
• ASSET PURCHASES: Forecast to maintain the pace of asset purchases at EUR 60bln per month until December 2017. Last December, the ECB reduced the size of purchases by EUR 20bln per month, and extended the purchase horizon by nine months.

PRESS CONFERENCE

CURRENT ECB FORWARD GUIDANCE

• RATES: “The Governing Council continues to expect the key ECB interest rates to remain at present or lower levels for an extended period of time, and well past the horizon of the net asset purchases.” (ECB statement, 27/Apr)
• ASSET PURCHASES: “Net asset purchases, at the new monthly pace of EUR 60bln, are intended to run until the end of December 2017, or beyond, if necessary, and in any case until the Governing Council sees a sustained adjustment in the path of inflation consistent with its inflation aim.” (ECB statement, 27/Apr)
• GROWTH: “Risks surrounding the euro area growth outlook, while moving towards a more balanced configuration, are still tilted
  to the downside and relate predominantly to global factors.” (ECB statement, 27/Apr)
• INFLATION: “Headline inflation has been recovering from the very low levels seen in 2016… Measures of underlying inflation remain low and are expected to rise only gradually over the medium term, supported by our monetary policy measures, the expected continuing economic recovery and the corresponding gradual absorption of slack.” (ECB statement, 27/Apr). Draghi: “For domestic price pressures to strengthen, we still need very accommodative financing conditions, which are themselves dependent on a fairly substantial amount of monetary accommodation” (29/May)

POTENTIAL ADJUSTMENTS TO FORWARD GUIDANCE/ROADMAP TO EXITING LOOSE POLICY

• RATES: Commerzbank doesn’t buy into the market speculation that rate hikes will come before the conclusion of asset purchases. It says the ECB would only pursue this approach “if its overall view of the situation changed substantially. Otherwise, this would undermine the credibility of forward guidance.”
• ASSET PURCHASES: A small tweak in guidance in June could open the door to announcing gradual tapering at the September meeting which will likely begin after December 2017, when the current programme of asset purchases comes to its end.
• GROWTH: The central bank is expected to amend its assessment of the balance of risks to state that ‘risks to the growth profile are now more balanced’. The central bank will, however, be keen to proceed cautiously so not to shift expectations too hawkishly.
• INFLATION: The ECB is likely to move gingerly given the risks presented by a possible fall-back of inflation, and the underperformance of wages. Additionally, there is a risk that political headwinds could return in the form of Italian elections, which are due to be called before the end of Q2, but may be announced earlier. (See next section for a more detailed overview of the inflation outlook)

ECB STAFF MACROECONOMIC PROJECTIONS

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Sources: ECB, Reuters, RANSquawk

INFLATION:

• At 1.40% y/y (Prev. 1.90%), headline inflation is currently sitting below the ECB’s 2.0% target despite being on an upward trajectory since the middle of 2016. Core inflation, however, has been more stubborn, but has risen to 1.20% y/y.
• Analysts at ING believe that there are risks that the ECB’s inflation forecasts could be revised lower: “While the effect of a stronger euro exchange rate and lower oil prices should net off each other in terms of growth, it could actually lead to a downward revision of the ECB’s inflation projections for 2017-19 by ~0.2ppt each year.”
• The latest ECB sources suggest that the central bank will trim their inflation outlook tspanough 2019 with 2017, 2018 and 2019 CPI expected by the bank to print at around 1.5% (see above for previous’)
• Note: The ECB assumed a EURUSD rate of 1.07 in its March forecasts; the median long-term projection of analysts surveyed by Reuters is 1.10. The central bank also forecast crude prices at USD 56.4/bbl in 2017, USD 56.5/bbl in 2018, and USD 55.9/bbl in 2019.

REAL GDP:

• Flash estimates for Q1 indicated growth of 0.50% q/q (16 quarters of consecutive positive quarterly growth) and 1.70% y/y (14 consecutive quarters of annualised positive growth). Prior to Thursday’s release.
• The latest ECB sources suggest that the central bank will revise higher growth forecasts by 0.1pp.
• Analysts at UBS believe there may only be limited scope for upward revisions to the growth profile, however: “Staff projections from March were already quite constructive, both against our own forecasts and the consensus. Hence, while the strength of the latest growth data and the PMIs might suggest further upside to the ECB's growth projections, we expect any upward revision to be small.”

MARKET REACTION

In terms of the rate decision itself, little market reaction is expected at this point unless the rate decision is accompanied with a statement from the ECB that policy announcements/adjustments are to be announced alongside the press conference. The market reaction will likely hinge on how dovish/hawkish the ECB with regards to the economic outlook and how suggestive they are with to regards to curtailing bond purchases. More specifically, dovish elements could include (as detailed above) the ECB being particularly non-committal with regards to QE tapering, downbeat on the inflation outlook given the recent decline and maintaining current forward guidance on rates. If this was the case, EUR would likely lose ground against its major counterparts, upside would be seen in European equities and a steepening of the curve. The converse would be expected if the ECB provided a more hawkish release with hints/details of a potential conclusion to asset purchases, looking tspanough the recent downtick in inflation and removal of the ‘or lower’ bias on their rate path. That said, UBS suggest that any potential dovish reaction to the release could be short-lived as QE tapering remains ‘inevitable’.