We expect the ECB to maintain its patient stance at the meeting this week and not send any new signals about more easing. An important argument for the ECB to remain patient is that financing conditions have improved - lately this is seen by lower real swap rates due to higher near-term market-based inflation expectations.
The minutes from the latest ECB meeting in April clearly confirmed that the ECB is in implementation mode. It stated that patience was needed for the measures to fully unfold and, importantly, the ECB argues that it is adding additional accommodation in June, due to the first TLTRO II auction and the beginning of purchases of corporate bonds.
The ECB will publish updated growth and inflation forecasts at the meeting this week. We look for an upward revision to the ECB's projection for headline inflation in 2016-17 due to the higher oil and food prices, but the core inflation forecast will in our view be revised lower over the entire forecast horizon. Notably, the ECB might revise its 2018 headline inflation forecast lower.
From a market perspective, expectations are very low with a zero probability of a 10bp deposit rate cut at the upcoming meeting. We stick to our view that the ECB will remain side-lined in the global currency war and not cut policy rates further.
We still believe that the ECB will have to extend its QE purchases beyond March 2017 as the ECB in our view will not see inflation at a sustainable path towards 2%. We look for a considerable rise in inflation starting from June this year, but support from oil prices will fade in Q2 17.
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