By Balazs Koranyi and Francesco Canepa
FRANKFURT (Reuters) – The European Central Bank is expected to lay the groundwork for an autumn policy shift when it meets on Thursday, emphasising improved growth while tempering expectations after previously setting off a mini tantrum in financial markets.
ECB President Mario Draghi opened the door to policy tweaks in a speech in Sintra, Portugal, last month that was viewed as unexpectedly hawkish.
He is unlikely to backtrack, but may temper or at least nuance the message to keep markets at bay.
With the end of unprecedented central bank stimulus now within sight, financial investors are nervously sifting through clues, trying to gauge how big central banks around the globe will unwind unconventional policy that have kept borrowing costs at rock bottom.
A key discussion for the ECB on Thursday may be whether policymakers should remove their pledge to increase the volume or duration of asset buys if the outlook worsens, a topic already discussed in June when further rate cuts were ruled out.
Such a move was seen by some as a foregone conclusion until Draghi sent bond yields and the euro <EUR=> sharply higher when he argued in Sintra that improved growth may provide room for the ECB to tighten policy.
But policymakers speaking to Reuters earlier voiced concern about doubling German 10-year yields and the euro’s 3 percent rise, fearing that a fresh signal now may be self defeating, pushing up borrowing costs and thwarting a broadening but still relatively young recovery.
“After the ‘Sintra hiccup’, the ECB for next week has to choose between ‘backtracking’ and ‘assuming’,” Bank of America Merrill Lynch said. “We think they will choose the latter.”
“It probably makes sense to gently steer the market towards acceptance of a prudent pace of tapering now rather than creating more complacency, at the risk of an abrupt wake-up surge in volatility later,” it added.
The ECB has to resolve an apparent disconnect between weak inflation and improving growth.
Buying trillions of euros worth of bonds to cut borrowing costs, it has fought off the threat of deflation and helped rekindle growth, now on its best run in a decade.
But inflation, its chief focus, will continue to undershoot its target of almost 2 percent at least through 2019, indicating that even if it eased off the accelerator, easy monetary policy will continue for years to come.
Most analysts polled by Reuters expect no change on Thursday but a sizable minority predicted a tweak in the bank’s guidance with a compromise possible on axing a bias for increasing purchases but not in the case of the extension.
The ECB announces its rate decision at 1145 GMT, followed by Mario Draghi’s news conference at 1230 GMT.
While the bank is not under pressure to make a call on the future of asset buys now, they are now set to run until the end of the year.
So by September, or October at the latest, policymakers have to decide whether to extend the buys or wind them down in a process called tapering.
Most economists polled by Reuters expect tapering from next year but unlike the U.S. Federal Reserve, which cut buys at each meeting when it ended its own asset buys, the ECB could simply extended the buys at a lower volumes to avoid creating an impression that it was on a preset course to wind down the buys.
Indeed, policymakers told Reuters earlier that they would not want to put an end date on the buys or a schedule on tapering, maintaining flexibility and avoiding a perception that it was on a preset course.
“On the one hand, the ECB wants to prepare financial markets for tapering, without creating a ‘taper tantrum’,” ING economist Carsten Brzeski said.
“On the other hand, in a world without inflationary pressure, the ECB will have to substantiate the tapering preparation with economic arguments that do not leave market participants completely stumped; a balancing act that requires all of Draghi’s verbal acrobatic skills,” Brzeski added.
Global central bank balance sheets http://reut.rs/2u657VF
(Reporting by Balazs Koranyi Editing by Jeremy Gaunt)
By Balazs Koranyi and Francesco Canepa