Eyeing the easy money exit: Five questions for the ECB

[March 06, 2018]   By Dhara Ranasinghe and Ritvik Carvalho

LONDON (Reuters) - As European Central Bank policymakers get ready to meet on Thursday, market focus turns once more to just when the central bank will wind up its massive stimulus scheme.

While the ECB is expected to maintain a cautious policy stance, economists say a robust economic backdrop could make it increasingly difficult to maintain the so-called easing bias -- a stipulation that the bank can increase asset purchases if necessary.

Here are some of the main questions on the radar for markets ahead of Thursday's meeting.

1. Could the ECB drop its easing bias on QE?

Policymakers are likely to discuss dropping their easing bias but a broader revision of the bank's policy guidance is likely to happen later, possibly during the summer, sources close to discussions told Reuters last week.

While no major change is expected at the March 8 meeting, almost a third of 56 economists polled by Reuters said the central bank could drop its easing bias on asset purchases.

Analysts said any drop in the bias could strengthen the euro and push up bond yields, although bigger changes to the ECB's "forward guidance" are more likely to come in June.

(GRAPHIC: The ECB's QE programme - http://reut.rs/2FiEeks)

2. Does that mean we can expect a "hawkish" ECB meeting?

Hardly. The ECB is likely to avoid any steps that would spark an unwarranted rise in the single currency or euro area borrowing costs. That means any drop in the QE easing bias would probably be balanced by an overall cautious tone.

No major policy shifts are expected on Thursday, sources told Reuters last week. Recent market turbulence, a strong euro, a dip in inflation and political deadlock in Italy after weekend elections could encourage policymakers to strike a cautious tone.

But there is little doubt about the direction of policy and investors still anticipate an ECB rate rise in early 2019.

(GRAPHIC: Money markets bring forward bets on timing of ECB rate hikes - http://reut.rs/2D438SS)

3. How does a strong euro feed into the ECB's deliberations?

Since the ECB's Jan. 25 meeting, the pace of the euro's rise has cooled a bit and the currency has declined nearly 2 percent. But the euro has not lost any ground when measured on a trade-weighted basis <EUREER=ECBF> and briefly hit a more than a three-year high above $1.25 <EUR=EBS> last month.

ECB chief Mario Draghi skirted the question of the strong euro in January by saying the bank did not target exchange rates, but he may be confronted on the currency again as economic momentum stalls after a strong start to 2018.

The European Central Bank (ECB) headquarters are pictured in Frankfurt, Germany December 14, 2017. REUTERS/Ralph Orlowski

A Citigroup economic surprise index <.CESIEUR> has fallen to its lowest level since 2016, dropping into negative territory which reflects that economic releases have on balance come in below consensus forecasts.

(GRAPHIC: Economic surprises in Europe turn negative - http://reut.rs/2FjUVfx)

Any word of caution on the firm euro could spark a washout of long positions in the markets where bets on further euro strength are near a record.

4. Could the ECB change its inflation forecasts?

The ECB is due to publish its economic forecasts on Thursday but significant changes to its estimates of future inflation and economic growth are not expected by economists.

"The combination of slightly higher oil prices, food prices and a stronger currency is likely to be neutral in terms of inflation projections," said Pictet Wealth Management economist Frederik Ducrozet.

Euro zone inflation slowed to a 14-month low in February and remains below the ECB's near 2 percent target. A key market gauge of euro zone inflation expectations is at 1.70 percent <EUIL5YF5Y=R> and close to its lowest this year, highlighting that low inflation remains a key obstacle to policy "normalization."

(GRAPHIC: Inflations drifts further away from ECB target - http://reut.rs/2FiEeAY)

5. How worried is the ECB about a global trade war?

Given that Draghi took a swipe at Washington at his last news conference for talking down the dollar, investors will listen out to any comment from the ECB chief about U.S. President Donald Trump's plan to slap steep import tariffs on steel and aluminum.

Worries about a trade war have rattled world markets, dealing a blow to the dollar and threatening further upward pressure on euro -- an unwelcome development for policymakers since the strong euro keeps inflation down and could complicate the ECB's exit strategy from quantitative easing.

(GRAPHIC: Euro strength - http://reut.rs/2FhIjK0)

(Reporting by Dhara Ranasinghe, Saikat Chaterjee and Fanny Potkin; Graphics by Ritvik Carvalho; Editing by Catherine Evans)

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