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European Central Bank may hold off on rates, wait for Fed

A tourist takes a picture of the euro sign landmark outside the former headquarters of the European Central Bank (ECB) in Frankfurt, Germany.
Kai Pfaffenbach | Reuters

FRANKFURT — U.S. investors will turn their attention to Frankfurt this week as the European Central Bank kicks off a big month of monetary policy decisions.

Some economists said the possibility of a U.S. Federal Reserve rate hike is one of the many reasons the ECB is expected to take a wait-and-see approach.

As the ECB Governing Council meets Thursday, predictions about U.S. interest rates fluctuate almost with every release of economic data. Most Fed watchers now don't see a rate hike until December, but some still expect to a tightening of monetary policy as early as the U.S. central bank's Sept. 20-21 meeting. The Bank of England and Bank of Japan, meanwhile, could announce additional policy easing in coming weeks. This dynamic puts ECB President Mario Draghi in a difficult position as the first central banker to take the stage, economists said.

"While officials in the U.S. are keeping a rate hike on the agenda, the timing of a possible move remains unclear and it is Draghi who has to make the first bid this month, ahead of the BOE, ahead of the Fed and BOJ," said Natascha Gewaltig, director of European economics at Action Economics. "So he won't have the benefit of hindsight this month."

Gewaltig said the ECB faces uncertainties over Europe's inflation outlook, effects of the Brexit referendum and the limits of its unconventional monetary policy. The central bank will likely take a dovish tone but remain on hold this week, weighing options like expanding its quantitative easing program, she explained.

Analysts also said the ECB may want to wait for the Fed decision later this month before announcing any new policy measures.

"It's difficult for many central banks to act before the Fed," said Nordine Naam a senior forex analyst at Natixis. "For the ECB, it could be easier to wait and to keep the ammunition."

'Growing concern, skepticism'

Naam said he expects the dollar to strengthen on positive third-quarter U.S. economic data and predictions of gradual Fed tightening. In turn, a weaker euro could relieve the ECB's need for new easing efforts on top of the massive stimulus package the central bank unveiled last March.

That announcement included lowering the deposit rate further into negative territory to -0.4 percent, an expansion of the asset purchase program to 80 billion euros (about $90 billion) per month and a new series of longer-term refinancing operations.

The chances of the ECB sitting tight in September are "helped by the fact that monetary policy is still becoming more accommodative as the measures announced in March continue to be enacted and kick in," said Howard Archer, IHS Global Insight's chief European and U.K. economist.

Economic data in the euro area have remained surprisingly resilient throughout the summer, despite uncertainties over how and when the United Kingdom could exit the European Union, said Societe Generale economist Anatoli Annenkov. But euro zone inflation remains well below the ECB's target of nearly 2 percent. In response to low inflation, Annenkov expects the ECB to announce an extension to the time frame for its asset purchases, which currently run through March 2017.

"It's really to reassure us all that they are able and willing to continue the program for a bit longer next year," Annenkov said. "I think a lot of people see that will be needed given the poor inflation outlook we have at the moment."

In the absence of a major policy announcement, Carsten Brzeski, chief economist at ING Germany, said he expects Draghi to strike a dovish tone in his news conference, in order to reassure markets that the ECB has the tools it needs to achieve its inflation mandate. The ECB president is likely to intensify his calls for governments to step in with structural reforms to help boost economic growth, Brzeski added.

"The ECB is getting a bit desperate," he said. "There is this growing concern, skepticism, about what central banks can still do."

Brzeski added that Fed tightening would mean a relatively stronger dollar and weaker euro, which could help the ECB move toward its macroeconomic goals.

"I don't see the Fed hiking in September but of course if they would, it would make life at the ECB easier," he said.