Draghi Set to Tell Tale of Stimulus Undercut by Brexit Woes

The Calm Before the Storm? Draghi May Shake Things Up
  • ECB president will present new economic forecasts on Thursday
  • Boost to outlook from bond buying seen as weakened by Brexit

Mario Draghi had a chance to upgrade the European Central Bank’s economic outlook. Then Brexit probably took it away.

When the ECB president lays out fresh growth and inflation projections for the euro area on Thursday, they’ll likely be little changed from three months ago. But those forecasts will mask an underlying picture that has changed dramatically as the U.K.’s decision to quit the European Union adds to the region’s political and banking crises.

The updated outlook will play a key part in the Governing Council’s meeting in Frankfurt this week. Before Brexit, some policy makers had suggested the projections might be revised upward, affirming that current stimulus is sufficient. Now most economists surveyed by Bloomberg predict that downside risks will force the ECB to extend quantitative easing before the end of the year.

“This forecast round will take a more optimistic view on the ECB’s measures and their impact on inflation,” said Anatoli Annenkov, a senior economist at Societe Generale SA in London. “But then there’s the Brexit story. The two will cancel each other out, which means forecasts will more or less stay where they are.”

One euro-area official, who spoke on condition of anonymity because the forecasting process is confidential, said the ECB won’t change its inflation outlook for 2016 to 2018 from the last round in June, and its predictions for gross domestic product will be cut slightly for the next two years. Such projections aren’t final until they are published, and a spokesman for the central bank declined to comment on the matter.

Economists surveyed by Bloomberg predict the ECB will lower its 2017 growth forecast from 1.7 percent and keep all other projections -- including an estimate for inflation of 1.6 percent in 2018 -- unchanged.

It could have been worse. The ECB is shielded by its conservative approach to measuring the impact of its non-standard tools. The effect of quantitative easing and bank loans is difficult to grasp with traditional economic models, and policy makers signaled in June that their projections at the time didn’t fully capture the actions already announced.

Draghi pointed to additional stimulus in the pipeline beyond the impetus already taken into account, ECB Vice President Vitor Constancio expressed confidence that inflation will rise faster than predicted, and council member Ardo Hansson said he sees upside potential to the forecasts.

In Sweden, the Riksbank maintained its economic outlook on Wednesday and decided against a rate cut or an extension of QE. Governor Stefan Ingves said that should the ECB deliver more stimulus, markets can rest assured that his monetary “toolbox is not in the closet.”

The ECB’s March and September projections are largely compiled by its staff in Frankfurt, while the outlooks released in June and December draw more on the national central banks. The procedures are similar, but the underlying models differ as every national institution uses their own mix of equations.

To account for the impact on the economy of non-standard tools, the ECB and its regional counterparts have added a number of satellite models and equations to their traditional calculations. Since the instruments are unprecedented, and so have no comparison, officials are careful in assessing their scope.

Learning Process

“We may well underestimate the impact of non-standard measures,” said Hermann-Josef Hansen, who heads the Bundesbank’s Macroeconomic Analysis and Projections division. “But given the uncertainty, caution seems appropriate. We are in a learning process.”

The June and December projections are produced by the Working Group on Forecasting, which comprises macroeconomic and econometric experts from across the region. They’re overseen by the Monetary Policy Committee, made of senior staff from national central banks and the ECB.

After the technical assumptions are discussed in an initial meeting, the national institutions produce forecasts for their country, an effort duplicated at the ECB. Those draft projections are assessed in a teleconference together with a referee -- in the Bundesbank’s case it’s the Bank of France -- before a second meeting concludes the process. The ECB uses the national forecasts to produce its outlook for the 19-nation region.

For the March and September projections, national central banks only contribute the short-term outlook for inflation, which -- after more than three years of falling short of the ECB’s target -- is increased reason for concern.

At their last meeting in July, policy makers saw “no clear upward trend” in consumer-price growth and called for further analysis into the divergence between survey and market-based inflation expectations. Inflation unexpectedly stagnated at 0.2 percent in August. The ECB’s medium-term goal is just under 2 percent.

With Brexit now clouding euro-area prospects that are already damped by an Italian banking crisis and the third parliamentary elections in less than a year in Spain, economists predict more stimulus will be announced, perhaps as soon as Thursday. Updated forecasts often underpin a decision to change policy, and Draghi said in July that they will put policy makers in a “better position” to decide whether they need to act.

“Easing is warranted given lackluster growth and very little sign of rising underlying inflation pressure,” said Nick Kounis, head of macro and financial-market research at ABN Amro Bank NV in Amsterdam. “On the other hand, the ECB is reluctant at least at the moment. There may be questions marks whether more asset purchases can change the trend dramatically.”

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