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Investors Might Be Underpricing ECB’s Desire for a July Move

Investors betting the European Central Bank will wait until September before ramping up monetary stimulus may be underestimating the risk of earlier action.

The latest reports suggest the economy is still limping, giving President Mario Draghi reasons to follow through on last month’s pledge that the ECB will act if the outlook doesn’t improve. A survey of investors this week suggested a German recession is likely, and factory orders are plunging. Confidence among French manufacturing executives is at its weakest in six years.

Draghi’s eight-year term has been marked by bold action, including an interest-rate cut at his first policy meeting, his “whatever it takes” pledge, negative rates and massive bond-buying. Yet markets are only pricing a 10 basis-point cut in the deposit rate by the Sept. 12 meeting.

Economists also see officials waiting until then, using the July 25 gathering to signal a reduction is imminent, and holding off from resuming bond purchases until September or later.

Importantly, two of his colleagues on the six-person Executive Board — the two who make presentations to the council — have given recent speeches suggesting a need to move fast. Chief economist Philip Lane said central banks must be “proactive” and Benoit Coeure, head of market operations, said loose monetary policy is needed now “more than ever.”

“The recent comments from officials suggest that the balance of risks are toward earlier moves,” Nick Kounis, an economist at ABN Amro NV in Amsterdam, said in a note to clients. For now, he’s still predicting a rate cut in September, followed by a second cut and renewed QE early next year.

If Draghi does try to push ahead in July, he may have to overcome some resistance on the board and on the Governing Council.

Board member Yves Mersch said last month that the ECB should avoid “erratic policy debates for the purpose of creating short-term stimulus.” Bank of France Governor Francois Villeroy de Galhau stressed on Monday that officials have “several Governing Councils to come in the next months” in which they could take any decision. Draghi could also leave the decision to his successor Christine Lagarde, who takes the reins as president from Nov. 1.

One concern is that the ECB won’t have updated economic projections until September. Those forecasts are a useful justification for a move if they show the outlook deteriorating. Conversely, taking action in the absence of new predictions risks sparking concern in markets that ECB officials are exceptionally worried about the the economy and inflation.

Despite the slowdown and plenty of weak data, there are occasional bright spots. Unemployment continues to drop, putting upward pressure on wages, and German industrial output and exports improved in May. The European Commission will publish its quarterly economic forecasts on Wednesday.

What Our Economists Say:

“The Governing Council tends not to make big policy changes without fresh economic forecasts to consider — the next batch won’t be readied until September. Still, the speed with which clouds have gathered over the euro-area economy means action could come sooner. While we expect a change to forward guidance at the July meeting, to signal that stimulus is imminent, the chances of an early rate cut have risen.”– Jamie Murray, chief European economist

Also important is the U.S. Federal Reserve’s policy decision at the end of this month, a week after the ECB meeting. A Fed cut could push the euro higher against the U.S. currency, further damping euro-zone inflation and giving the ECB reason to step up its own stimulus.

Investors have pared back bets on a Fed rate reduction of as much as 50 basis points after an unexpectedly strong jobs report last week. Governing Council members may prefer to wait for that decision before acting.

Another factor they’ll need to consider is the extent to which global trade tensions are weighing on confidence. Draghi justified his change of language last month by saying the “lingering uncertainty” is in itself a materialization of economic risk.

Since then, the U.S. has since agreed to postpone more tariffs on China as it extends talks. While that has cleared some of the clouds, it might not last. President Donald Trump has made clear he’s willing to impose levies on the European Union, which he believes is unfairly weakening the euro with loose monetary policy.