With many market watchers expecting the bank to announce in September plans to reduce its bond-buying program, the European Central Bank (ECB) is widely expected to hold interest rates steady.

As a sign that the central bank could start “tapering” earlier than expected and was more optimistic about the economy, ECB President Mario Draghi’s speech in Sintra was interpreted by many economists. In order to prevent an unwanted tightening of monetary conditions, the ECB has tried to calm down those expectations since his speech in June.

“Our mission is not yet accomplished. We need patience and persistence. We need to be patient, because inflation convergence needs more time to show through convincingly in the data,” the ECB’s Chief Economist Peter Praet said in a speech July 6 in Paris. In the same speech, he also said that the recovery in the euro zone “seems to have gathered further momentum.”

Inflation is nowhere close to target of below but close to 2 percent, with both hard data and also sentiment indicators pointing to a solid recovery, while economic growth is surprisingly strong and that’s exactly the difficult situation the ECB is in. With core inflation though slightly increasing by 0.2 percentage points to 1.1 percent, headline inflation for June even declined slightly to 1.3 percent from 1.4 percent in May.

“The ECB will continue to face little home-made inflationary pressure,” writes Carsten Brzeski, chief economist for Germany and Austria at ING-DiBa, in a note.

“If anything, the drop in oil prices, the pick-up in bond yields and the strengthening of the euro have further deteriorated the ECB’s inflationary outlook.”

the majority of economist polled by Reuters also expect Draghi to announce a reduction of the asset purchase program starting from January next year in September when new staff projections for inflation and growth will also be published.

And announced in Sintra was the statement that despite subdued inflation, the rationale for the ECB to start the “tapering”.

“As the economy continues to recover, a constant policy stance will become more accomodative and the central bank can accompany the recovery by adjusting the parameters of its policy instruments – not in order to tighten its policy stance but to keep it broadly unchanged,” Draghi said on June 27 in Sintra.

This assessment was also backed by other policy makers.

“Speeches by Praet and (Governing Council member François) Villeroy (de Galhau) have since made similar points, while the June accounts spoke of an “accelerator effect” suggesting that there may be room to “adapt the intensity” of policy action”, says Anatoli Annenkov, senior European economist at Societe Generale, in a note.

Without creating further distortions in the markets, for an exit of their ultra-loose monetary policy stance, the ECB clearly wants to prepare the markets. And for an exit of their ultra-loose monetary policy stance, that’s like a dance on a volcano.

A clear roadmap to the market of what will happen to the asset purchase program in 2018 may be obtained therefor in September which is the new “D-Day” for this purpose. A six-month extension with a reduced volume is expected by the majority of economists.

“The ECB will be in the markets for a long time”, Draghi said at the ECB’s last monetary policy meeting in Tallinn.

(Adapted from CNBC)

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