The strong economic data coming out of the eurozone should be a focus for investors as it has the potential to affect the European Central Banks’ Asset Purchasing Program, according to AllianceBernstein.
The euro area composite purchasing managers index, as well as both core and headline inflation, have been rising steadily, the company said, and investors need to consider whether the European Central Bank (ECB) may pare back its Asset Purchasing Program (APP).
AllianceBernstein senior European economist for global economic research Darren Williams said the ECB would not change its APP in the near term, but cautioned there was a chance, albeit unlikely, that “the ECB’s resolve could be tested” moving further in to the new year.
“The euro area ended 2016 on a firm footing, with both survey and hard data pointing to annualised growth close to 2.0 per cent – which is likely to be some way above trend for the region,” he said.
“With monetary and fiscal policy supportive and the global economy perhaps moving into higher gear, there’s no reason, barring an external shock, why the euro area economy can’t continue to grow at around this pace in coming quarters.”
Mr Williams said investors should focus on the ECB’s reaction function, saying that if this remains “static” that the bank will continue to buy bonds as expected, noting that “firmer growth and rising headline inflation are unlikely to be matched by a speedy pickup in core inflation” – with the latter a precondition for the ECB to taper its purchasing.
“But central bank reaction functions are not static,” Mr Williams cautioned investors.
“Before the global financial crisis, for example, the main driver of ECB policy was the growth rate of the economy. More recently, with inflation hovering around and below zero and deflation risk rising, policy decisions have been contingent on the need to drive inflation back to target as soon as possible; at times, the ECB has therefore eased policy with the economy growing at rates previously consistent with unchanged or even tighter policy.”
Mr Williams said it was unlikely the ECB would end up reneging on its commitment to asset purchasing, as core inflation is expected to rise to only 1.2 per cent by the fourth quarter of the year, but warned this was not far below the 1.4 per cent average core inflation rate seen since 1999.
“It wouldn’t take that much in terms of upside surprises to either growth or core inflation, for the ECB to revisit the risk-reward trade-off implicit in its current ultra-loose monetary stance,” he said.
“A further reduction in the monthly pace of asset purchases, or early tapering, is therefore something investors should have on their radar for the second half of 2017.”