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Will a Strong Euro Derail the ECB’s Normalization Plan?

PART:
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Part 2
Will a Strong Euro Derail the ECB’s Normalization Plan? PART 2 OF 3

How the ECB Could Handle Quantitative Easing in the Months Ahead

Update from the recent ECB meeting

The European Central Bank (or ECB) left the policy rates, its quantitative easing program (or QE), and its forward guidance unchanged at its recent meeting. Hawkish comments from the ECB chairman, Mario Draghi, before this meeting led the market participants into expecting a change of tone from the ECB. However, the ECB said that it was ready to increase the size of the QE program if economic conditions deteriorated again.

Regarding the European economy (VGK), Draghi said the financial conditions in the European Union remain broadly supportive. Draghi noted that the QE program has helped keep the bond (BND) yields lower and the spreads tighter. Some of the ECB members had concerns about the lower levels of inflation (TIP) and an appreciating euro (FXE).

How the ECB Could Handle Quantitative Easing in the Months Ahead

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The ECB’s view of inflation

The ECB now seems to be focusing on the inflation outlook along with economic recovery in the region. Draghi acknowledged the impact of monetary policy on inflation, and it could take longer than expected to reach its inflation targets.

The last inflation reading for July was 1.3%. However, an appreciating euro (EUFX) in recent months is expected to have a negative impact on inflation in Europe (EZU).

Lower inflation could keep the ECB dovish

Lower levels of inflation due to a stronger currency could pressure the ECB to continue with its dovish stance. The current QE program could run at 60 billion euros per month until the end of 2017, as indicated by the ECB. The program could continue at a reduced pace throughout most of 2018, which the ECB is expected to announce during its September meeting.

In the final part of this series, we’ll discuss the impact of a stronger euro on the ECB.

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