Carsten Brzeski, Chief Economist at ING, suggests that all eyes are once again on Mario Draghi, hoping that he can perform his magic and pull a white rabbit out of his hat at this week’s ECB meeting. Key Quotes “To give the ECB some credit: the concerns voiced at the January meeting were justified. Since the January meeting, the Eurozone economy has actually done what the ECB had feared: slowing down. Confidence indicators have taken an enormous hit and both headline and core inflation have come down. Even though the only hard data available so far for January was positive (retail sales), it seems as if the Eurozone economy is suffering under a weaker external environment and political uncertainties in a couple of member states. Special focus will be on the latest ECB staff projections. Maybe not the only, but clearly one of the most important elements for the ECB to decide on further action. Back in December, the outlook for both growth and inflation was relatively stable, tilted to the positive side. The weaker external environment and the drop in confidence indicators since then have made a downward revision of both the growth and inflation projections very likely. In our view, the key forecast for ECB policy-making will be the inflation forecast. Just looking at the external assumptions of oil prices and the exchange rate, the further drop in oil prices and the appreciation of the nominal effective exchange rate could easily shave off another 0.3 percentage point of the December inflation forecasts (1.0% for 2016 and 1.6% for 2017). However, not all ECB members seem to subscribe to this pessimistic take on the outlook. Bundesbank President Weidmann has repeatedly stressed that the Eurozone recovery was still in place, benefitting from lower energy prices. Delicately, Weidmann will not hold a voting right at this week’s meeting. With faltering growth momentum, another downward revision of the inflation outlook and the echoes of Mario Draghi’s comments at the January meeting, the ECB will have no other option than to announce more monetary stimulus. As illustrated in the minutes of the January meeting, the ECB under Draghi is determined to rather act pre-emptively than stick to a wait-and-see stance. However, finding the right instruments has never been more difficult than at the current juncture. In fact, the ECB has almost come to the point at which more action could potentially do more harm than good. In particular, this holds for a further lowering of the deposit rate. Being the new hype amongst central bankers, negative interest rates are supposed to weaken the exchange rate. This channel worked last year but is unlikely to work this time around as the fate of the euro-dollar exchange rate is currently almost exclusively determined by the Fed. Only a positive surprise could revamp this channel. At the same time, a further cut in rates could have adverse effects on the banks. Negative interest rates are hurting bank profitability, putting more pressure on cost cutting and eventually bringing banks into more problems. Despite increased risks related to further action, inactivity seems to be the worst option for the ECB. Therefore, we think that Draghi will deliver a mix of several small, but above-consensus, steps: a cut of the deposit rate by 20bp, either in a two-tiered form or with some other compensating measures for the banks, a broadening of the scope of QE and a small €5bn increase of monthly QE purchases. On top of all, some verbal intervention suggesting that the ECB would tolerate overshooting of the inflation rate would also help propping up inflationary expectations. It has the potential for a short-term surprise but in the longer term it could still turn out to be a parlour trick and not a white rabbit.” For more information, read our latest forex news.