Watch Out! ECB To Tighten Soon.

July 3, 2017

| Fullerton Markets

ECB may start to consider QE exit in coming months, long EUR/USD?

ECB could be ready to exit QE, EUR/USD surges

EUR rallied across the board and it is likely to continue. ECB’ s Mario Draghi said last week, deflation is now off the table in euro zone and monetary policy is effective. “Reflationary forces” are working their way through the economy, paving the way for normalisation.

“As the economy continues to recover, a constant policy stance will become more accommodative, and ECB can accompany the recovery by adjusting the parameters of its policy instruments, not in order to tighten the policy stance, but to keep it broadly unchanged”, said Mario Draghi. The message is clear: ECB needs to be patient in letting inflation pressure build up in the euro area and prudent in withdrawing support. However, there is room to tweak existing measures.

The comments echoed an argument first made by Bundesbank President Jens Weidmann last November, all else being equal, ECB policy would become more accommodative as inflation picks up. With his nod to a frequent critic of QE who has been calling for an end of the 2.3 trillion-euro program, Draghi may have set the stage for a discussion in the coming months on phasing out asset purchases. The program is scheduled to run until the end of the year. There is a possibility ECB may discuss about the “exit strategy” as early as September.

While acknowledging the improving prospects of the euro zone and the key role played by monetary policy in fostering the upturn, Draghi said weak oil prices are partly to blame. In contrast to a similar plunge two years ago, he stressed that this time, policy makers can afford to wait for the energy effects to wear out, this may well suggest the ultra-loose monetary policy in the euro zone is near the end. In recent oil plunge, the drivers of low oil prices are mainly supply factors, which a central bank can typically look through. Even if supply factors affect the path of inflation for some time, with inflation expectations secured, they should not ultimately affect the inflation trend.

Bank of Japan may consider more tightening at the year end

Japan is having its longest economic expansion in a decade with gross domestic product increasing for a fifth straight quarter, though the latest inflation data show it’s still some way from the BOJ’s 2% target. However, Japan’s growth surprised on the upside, as has happened in Europe. Kuroda will also have to start talking about some sort of exit, or at least raise the peg on 10-year yields from zero.

If the prediction does come true, we think USD/JPY may target 105 towards end of fourth quarter.

Our Picks

EUR/USD – Slightly bullish. We think this pair may move towards 1.1450.