World Economy

ECB May Tighten Policy Soon, Review Rising Euro

From this month, the ECB has halved the amount of cheap cash it is pumping into the system under its QE program
ECB warned the euro’s surge was a potential risk and said it might have to review its strategy.ECB warned the euro’s surge was a potential risk and said it might have to review its strategy.

The eurozone's economy could prove to be a shining star again this year, but persistently tepid inflation will probably keep the European Central Bank from following its peers and tightening monetary policy anytime soon.

Reports coming on Tuesday are expected to show 2017 was the bloc's best year for growth in over a decade, capped off by a strong fourth quarter. Purchasing managers' indexes released for January already suggest that momentum accelerated into this year, Reuters reported.

Such growth rates are fertile ground for tighter policy but a strong euro, up around 4% this year, is exacerbating a battle the ECB is facing in trying to get inflation up anywhere near its 2% target ceiling as it makes imports so much cheaper.

On Thursday, having left policy unchanged, the bloc's central bank warned the euro's surge was a potential risk and said it might have to review its strategy if US comments on a weak dollar led to a change in monetary conditions.

"The recent volatility in the exchange rate represents a source of uncertainty which requires monitoring with regard to its possible implications for the medium-term outlook for price stability," ECB President Mario Draghi told a news conference.

"Based on today's data and today's projection I see very few chances at all that interest rates will be raised this year."

From this month, the ECB has halved the amount of cheap cash it is pumping into the system under its quantitative easing program to €30 billion ($37.3 billion) per month, and currently envisages halting asset purchases in September.

Yet the first hike in interest rates—and then of the currently negative deposit rate—is not predicted to come for at least another year, the Reuters poll found. The refinancing rate probably won't rise until the latter half of next year.

"We remain confident that there will not be any key policy rate moves this year in light of Draghi's comments," said Simon Wells, chief European economist at HSBC.

Fed's Tapering

In contrast, the United States Federal Reserve has already embarked on a tightening cycle and if a Reuters poll is to be believed its change of leadership is unlikely to derail it from increasing borrowing costs three times this year.

Its economy is expected to grow 2.6% in 2018, the best performance in three years, fuelled in part by a sugar rush from the biggest tax overhaul since the 1980s. And a weaker greenback should keep inflation elevated.

"With momentum in aggregate demand, tightening labor markets, some evidence of a rebound in inflation, and resilient financial conditions, we expect three hikes in 2018 and one more in 2019," analysts at Nomura wrote to clients.

"Besides Governor (Jerome) Powell as the new chair, significant turnover in Fed leadership is widely expected, but we do not expect this to cause a material change in the near-term trajectory of monetary policy."

The Fed has its first meeting of the year in the coming week, but with it being Janet Yellen's last meeting as chair no change is expected.

Hiking Rates

North of the border, the Bank of Canada kicked off 2018 by hiking interest rates, buoyed by robust job growth and having raised rates twice back-to-back last year, even as uncertainty around the fate of the North American Free Trade Agreement lingers.

Two more increases will come in 2018, a poll found. Governor Stephen Poloz said last month he is increasingly confident the economy will need less stimulus over time.

Current negotiations to reform NAFTA will probably prove successful with only marginal changes, said a large majority of economists in a Reuters poll, despite saber-rattling from US President Donald Trump's administration.

Britain, undergoing its own tricky negotiations as it tries to untangle itself from the European Union, is facing the opposite problem to the currency bloc with a weaker sterling since the Brexit vote driving inflation well above the Bank of England's target of 2%.

But coupled with that, growth has slowed as businesses and consumers postpone spending decisions to see how divorce talks develop.


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