The main focus at the ECB meeting is likely to be how big a problem the current pace of euro appreciation is for the ECB . We expect Mario Draghi to express concern about this and explicitly mention that the stronger euro is the main reason the ECB has lowered its inflation projection and that there is further downside risk.
We do not yet expect the ECB to announce any decision about how QE will continue but we believe there will be a lot of discussion about the future QE path . The discussion is likely to be centred on the total stock of QE versus the effects of the monthly flow of the purchases, the impact on the economy of the composition of the QE purchases and the effects of the reinvestments.
We still believe the ECB will continue its QE purchases but at a reduced pace of EUR40bn per month in H1 18 . We expect it to announce this at the next meeting in October but with some signalling of it at the upcoming September meeting. An argument for signalling a QE continuation should be a downward revision to the ECB's inflation forecast. We expect a modest reduction to 1.2% in 2018 and 1.5% in 2019 driven by the euro appreciation.
From a fixed income perspective a dovish ECB would be positive for the periphery relative to core, especially if the ECB continues with its 'silent' but modest deviation from its capital key, where it buys more in, for example, Italy.
An ECB set to address the pace of EUR appreciation should help put a lid on EUR/USD near term . However, with the cross back around the pre-Jackson Hole level, the FX market should at least partly be ready to absorb some EUR worries from the ECB without this spurring a significant sell-off from here.
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