Salman Ahmed, Chief Investment Strategist and Charles St-Arnaud, Senior Investment Strategist, Lombard Odier IM comment on July’s ECB meeting

July’s ECB meeting showed a wedge between the underlying gravity of market moves, its tendency towards tighter financial conditions, and a Draghi led ECB, which is now explicitly operating under a persistence, patience and prudence driven framework.

They used the meeting as an opportunity to reiterate that ‘if the outlook becomes less favourable, or if financial conditions become inconsistent with further progress towards a sustained adjustment in the path of inflation, the Governing Council stands ready to increase the program in terms of size and/or duration’, suggesting a continued easing bias to monetary policy.

Considering President Draghi’s comments in Sintra, Portugal suggesting that deflation risk had disappear, some in the market expected the ECB to exhibit a more neutral bias to monetary policy in today’s statement and therefore holding status quo on the statement today was a dovish shift vs market expectations.

In the press conference, the ECB President said that the ECB kept the reference to the option to expand the quantitative easing (QE) program in an effort to prevent further unwanted tightening in financial condition that has resulted from the EUR appreciation and increase in yields. Moreover, despite the broad-based economic recovery, both headline and core inflation remain low and there are little signs of a pickup in underlying inflationary pressures. With this backdrop, the ECB feels that there is no rush to change its policy stance and can afford to wait for more information before taking a decision and that a decision should come in the autumn. As such, the ECB will have an updated staff forecast at the September meeting, which could provide it with more confidence on the outlook. President Draghi is also expected to speak at the Federal Reserve’s Jacksons Hole Symposium at the end of August. This could prove a good opportunity for Draghi to influence market expectations ahead of the September meeting, especially as he has shown to be a more independent operator during such as events.

The latest decision does not change our view on monetary policy in the euro area. We continue to believe that, in light of the broad-based cyclical recovery in the Eurozone, the decline in deflationary risks will eventually warrant a reduction in the amount of monetary stimulus from the current extraordinary level in the form of a reduction in the pace of asset purchases rather than immediate rate hikes.

However, ongoing weakness in inflation and fear of a policy mistake under a populism affected environment suggests stimulus remains needed and that there is no rush for even a marginal and gradual reduction in the amount of stimulus in the near term - a view which we think was confirmed by Draghi earlier today.


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