Federal Reserve who?

The European Central Bank will hold perhaps its most import policy meeting in three years later today in the Latvian capital of Riga with investors expecting the first official signal that its controversial $3 trillion quantitative easing program is about to come to an end later this year.

Investors looking for an outright shutdown of the program, however, which continues to purchase €30 billion ($35.5 billion) a month in government, corporate and agency bonds each month, could be disappointed by ECB President Mario Draghi, who is likely to use fresh growth and inflation forecasts to signal a slowdown in bond purchases while retaining enough room for future policy changes in the region's economy doesn't rebound -- and consumer prices ease -- in the second half of the year.

"We expect the ECB to adjust its guidance, but probably no yet, by formally deciding on scaling back asset purchases after September and ending them in late December," said Florian Hense of Berenberg Economics. "The current backdrop suggests there is no need to hurry. Going forward, we expect expect the ECB to end its net asset purchases in December 2018 and not raise its refi rate before June 2019."

The euro was marked at a near one-month high of 1.1825 against the U.S. dollar in early Frankfurt trading while benchmark 10-year German bund yields, a proxy for risk-free government bond rates, edged modestly higher to 0.48%.

Happy #ECB day! #buzzwordbingo today attached
- watch for 13:45 CET. If changes in APP it should appear there.
- 14:30 we expect Draghi with hawkish bits, c.f. Praet's comments on wage growth. last week.
For market reaction, see earlier posthttps://t.co/sR9CW359fi pic.twitter.com/wrDGlqkLOf

— Piet P.H. Christiansen (@pietphc) June 14, 2018

The decision to pullback from year of extraordinary stimulus, which have included not only the billions in bond purchases but also a negative rate on the Bank's deposit facility, record-low lending charges and billions upon billions of euros in liquidity support for the region's banks, would mark the first suggestions of policy tightening in Draghi's seven-year tenure in Frankfurt. It would also bring the ECB closer in-line with the U.S. Federal Reserve, which executed its seventh rate hike in three years last night that took its key lending rate to 2%.

Draghi, however, has a very different mandate to that of his opposite number at Fed, Jerome Powell,  and is only allowed to be guided on rates by the Bank's price stability target, which it defines as an inflation rate that sits "just below 2%."

Last month, the region's official statistics office said Eurozone inflation accelerated to 1.9% as a weaker euro and rising oil prices boosted headline consumer prices. Core inflation, as well, is also firming and with employment rising and wages slowing improving, the Bank's chief economist, Peter Praet said last week that it was time to "assess whether progress so far has been sufficient to warrant a gradual unwinding of our net purchases."

The Bank's path toward policy normaliztion, however, is likely to be a slow one, given not only the weakening growth dynamics in the region but also the simmering political tensions in Italy, where a the country's new populist government continues to suggest that it plans to add to its €2.3 trillion debt pile and potentially breach the European Commission's guidelines on deficit spending. 

Italy's benchmark 10-year borrowing costs have eased to around 2.8% in the weeks since Prime Minister Giuseppe Conte and the country's 66th government since the Second World War was sworn in two weeks ago, but that still marks a near 100 basis point increase from earlier this year.

ECB policymakers may also be spooked by the region's slowing growth outlook, particularly after IHS Markit's Composite PMI reading fell to an 18-month low of 54.1 in May, from 55.1 in the previous month, as business leaders reigned in investment plans amid the political chaos in Rome  and London and the ongoing trade war rhetoric in Washington and Beijing. 

"Despite growing uncertainty around the strength of the eurozone recovery, little underlying inflationary pressure and possible further market turmoil, the European Central Bank seems determined to focus on long-term trends," said ING's Carsten Brezski. "[But] we still don't think the central bank will easily give away flexibility and room for manoeuvre on quantitative easing in a situation where downside risks to the economic outlook have increased and political risks (be it from Italy or later this year from Brexit) could easily reemerge."

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