The more and more complicated task of adjusting monetary policy communication without triggering a sell-off will be on display at next week's ECB meeting.
We expect the ECB to strike a compromise between the doves (led by Draghi and Praet) and the hawks (led by Weidmann and Coeuré) where the ECB removes the QE bias, i.e. 'we stand ready to increase the asset purchase programme in terms of size and/or duration.' 'if the outlook turns less favourable'.
We expect the discussion to focus on the QE bias and not policy rate hikes, even despite Weidmann's call for specifying / quantifying 'well past'. In the ECBs words, 'well past' means data dependent.
We expect Draghi to strike a relatively dovish tone by inferring that the removal of the QE bias, should the outlook turn less favourable, is natural given the overall better shape of the economy. Recall that the wording was introduced in December 2016.
The January accounts showed that some members already expressed this view during the previous meeting.
As we expect Draghi to strike a relatively dovish tone, amid the removal of QE flexibility, we do not expect a sell-off in Bunds on the back of the ECB meeting, and expect the ongoing performance in the periphery to continue.
Looking ahead, we like the tactical forward steepener on the 10-30Y EUR swap curve that we proposed last year.
FX: ECB March shift to support EUR/USD only marginally. For EUR the key is that the ECB keeps up the sense of a continued move towards policy 'normalisation'. We think this will take EUR/USD towards 1.28 later this year, but near term we still see the cross in the 1.21-1.26 range.
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