Fighting the Economic Tide

Economic Reality Will Box Mario Draghi Into a Corner

Momentum has shifted to the hawks.
Hulton Archive/Getty Images

The European Central Bank policy could have ended its year with a non-event on Thursday, merely filling in the gaps left after October's decision to curb quantitative easing from January. Instead, policy makers are poised to unveil new growth and inflation estimates that will prove fundamental in dictating how next year unfolds.

At least six of the 25 governing council members have already called for QE to end in September, when the current extension is scheduled to expire. The hawks are pushing for greater emphasis on the ECB's forward guidance on interest rates. And the economic backdrop suggests they should win the argument.

The Laggards Gain Ground

GDP growth in Italy and Spain has boosted the region's recovery

Source: Bloomberg

Annual growth is not only accelerating -- it climbed 2.6 percent in the third quarter for the euro zone as a whole, its fastest pace since the start of 2011 -- it's also broadening to encompass peripheral countries. Moreover, Bloomberg Economics expects the ECB could raise its forecast for 2018, possibly above 2 percent, from the 1.8 percent it was predicting in September.

ECB President Mario Draghi is unlikely to alter dramatically his ultra-dovish line, continuing to emphasize the subdued nature of core inflation and stressing that upgraded price expectations are largely due to a 19 percent jump in crude oil prices this year. But his preferred measure of inflation expectations has been heading higher for several months.

Rising Tide

Draghi's favored guide to inflation expectations has climbed steadily since the summer

Source: Bloomberg

And it's not just the headline inflation figures that the ECB has to watch. Wages are steadily improving, albeit from a low base and remaining at levels that don't threaten to have a knock-on effect of inducing consumer prices to breach the target.

Show Me The Money

Wages are slowly recovering in the euro area

Source: Bloomberg Economics

Moreover, Thursday will provide a first look at the ECB's 2020 estimates. Proximity to the official target of an inflation rate below but close to 2 percent will weaken the case for extending QE beyond September. If momentum builds further next year it could rapidly reduce the time horizon the ECB has before seriously contemplating both finally ending the bond-buying program and raising interest rates.

Target in Sight

The ECB may raise its inflation forecast closer to its target of just below 2%

Source: Bloomberg Economics, ECB

By the time the ECB holds its post-meeting press conference, the Federal Reserve is likely to have raised its key interest rate for a fifth time in two years. Even the Bank of England has pushed up borrowing costs, though inaction is anticipated at its meeting Thursday.

Draghi has to maintain the unity of the governing council; with a quarter of his team already voicing doubts, it's only a question of limited time before economic reality boxes the ECB into following its peers and changing course away from ever-expanding stimulus.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

    To contact the authors of this story:
    Marcus Ashworth in London at mashworth4@bloomberg.net
    Mark Gilbert in London at magilbert@bloomberg.net

    To contact the editor responsible for this story:
    Jennifer Ryan at jryan13@bloomberg.net

    Before it's here, it's on the Bloomberg Terminal.
    LEARN MORE