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Strong Euro May Deter Draghi From Tapering, For Now

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The European Central Bank is set to adopt a highly cautious stance Thursday regarding any gradual withdrawal of monetary stimulus or "tapering," as a strong euro presents a tough conundrum for rate-setters, who are already flummoxed by the Eurozone's weak inflation amid solid growth.

The Governing Council, led by ECB President Mario Draghi, is widely expected to keep all three of its interest rates unchanged for a twelfth consecutive policy session and retain the EUR 60 billion monthly asset purchases that are set to run until the end of the year.

Additionally, caution is likely to prevail at the post-decision press conference as a possibly dovish Draghi navigates the subtleties of central bank communication with his verbal intervention tool to avoid feeding markets with hopes of an imminent tapering that could further strengthen the euro and hurt the euro area recovery.

"While a clear hint on tapering at this week's meeting could send the euro even higher, potentially undermining the recovery, room to postpone tapering is limited due to bond scarcity," ING Bank economist Carsten Brzeski said.

He added, "Therefore, we expect Draghi to strike a cautious balance between giving the first clear hint at upcoming tapering and adopting a dovish tone in order to calm the FX market."

Economists widely expect an actual decision on tapering in October. They also expect that a modest tapering would only start in January after the end of the on-going round of asset purchases.

Draghi will also unveil the latest ECB Staff economic projections during the press conference. Economists widely expect a further upgrade to the growth outlook but yet another trimming of the inflation projections.

In the previous round in June, the bank projected euro area growth at 1.9 percent this year, 1.8 percent next year and 1.7 percent in 2019. Inflation projections were cut to 1.5 percent for this year, 1.3 percent next year and 1.6 percent in 2019.

Meanwhile, ECB policymakers were already worried about a strengthening euro in July and pointed out the risk of the exchange rate overshooting in the future, the minutes of the policy session revealed. They also stressed that favorable financing conditions are still supported by the massive stimulus.

The euro has strengthened robustly since late June, when Draghi's comments in Sintra, Portugal, fed market expectations of an imminent tapering and sent yields and the euro soaring.

That said, a stronger euro could be reason enough for the ECB to delay its exit from the massive stimulus. Yet, the question remains - "For how long?"

Some analysts expect the ECB to entirely wind down its massive stimulus by the end of next year and start raising interest rates modestly in 2019.

by RTT Staff Writer

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