ECB officials have hinted at policy measures aimed at reducing the cost of negative rates for the banking sector, including a tiered system of bank reserves.Although back in 2016 the European Central Bank (ECB) ruled out tiering of bank reserves to mitigate the side effects of negative rates, the situation has since changed, and it could be implemented eventually if policy rates were to remain negative into 2020.

Last week, the European Central Bank (ECB) announced a new long-term refinancing package for banks (called TLTRO-III) and made clear that interest rates would not be raised this year. While these measures were expected, they have come earlier than we thought.

No changes to the ECB’s monetary stance and policy guidance mean we are holding to our forecasts for quantitative easing and rate hikes.The ECB made no change to its monetary stance and policy guidance at its 13 September meeting. The end of quantitative easing (QE) was confirmed for after December, following a final reduction in the pace of net asset purchases to EUR15bn per month in Q4 2018.Much of the focus was on the updated ECB staff projections.

Although euro area flash PMI indices were roughly in line with expectations in August, some details were less positive than the headline numbers, suggesting that downside risks have not yet disappeared. True, at face value, the small rise in the euro area composite PMI index, from 54.3 in July to 54.4 in August, is consistent with resilient real GDP growth, close to the 0.4% q-o-q pace recorded in Q2.

The ECB has had essentially two options going into the June meeting: either a dovish decision but a hawkish communication (hinting at an imminent QE tapering), or a hawkish decision but a dovish communication (counterb alancing a tapering announcement with dovish sweeteners).

German new orders were weak across the board in April, contracting for a fourth consecutive month and by a larger-than-expected 2.5% m-o-m following a downwardly-revised 1.1% drop in March. As a result, total manufacturing orders are off to an extremely weak start in Q2 (-3.3% q-o-q after -2.2% q-o-q in Q1). What is more, the decline in demand for German goods in April was fairly broad-based across countries and sectors.

Today’s release of euro area flash HICP surprised to the upside both in terms of headline inflation (which surged from 1.2% to 1.9% y-o-y in May, above consensus expectations of 1.6%) and, crucially, in terms of core inflation (HICP excluding energy, food, alcohol and tobacco rose from 0.7% to 1.1%).

A look at different scenarios for the ECB’s exit from quantitative easing and its expected rate hiking cycle.Our baseline scenario for ECB normalisation still holds. We expect QE to end in December 2018 and a first rate hike in September 2019. The ECB is likely to wait until its 26 July meeting to make its decisions on QE and forward guidance.Still, downside risks have risen to the point where another open-ended QE extension can no longer be ruled out, albeit at a slower pace, in order to postpone rate hike expectations.

The incoming government’s fiscal plans could result in a sharp deterioration of Italy’s public finances. However, broader fiscal metrics are better than they were during the euro sovereign crisis.The M5S-League coalition has committed to a significant degree of fiscal easing and to the reversal of some structural reforms. Such policies will put Italy on course for confrontation with Brussels over deficit reduction targets, although at this stage we still expect negotiations to result in compromises.For all the political and economic risks facing Italy, the difference in macro fundamentals between the situation today and the 2011 sovereign debt crisis cannot be stressed often enough. Italy has managed to run a primary surplus in 24 of the past 26 years, estimated at +1.5% of GDP in 2017.

Next week’s detailed breakdown of ECB QE monthly data will reveal a marked slowdown in the pace of corporate bonds purchases in April (Corporate Sector Purchase Programme, or CSPP). Indeed, weekly holdings data have been consistent with gross purchases of around EUR3bn in April, down from EUR5.8bn on average in Q1. There are several possible explanations for the drop in gross purchases, but redemptions are not one of them, as they amounted to just EUR87m in April.

This week’s Eurostat releases revealed that public finances continue to improve in most euro area member states. As a result of falling deficits, low interest rates and stronger nominal growth, the ratio of euro area government debt to GDP fell to a six-year low of 86.7% in Q4 2017.

Another ECB meeting, another balanced message of confidence and prudence. Unsurprisingly, the statement mentioned the deterioration in the data flow since March, but our impression is that the ECB is largely brushing off concerns about a soft patch in the economy for the moment.

The ECB’s Governing Council may have to wait a little longer to get a clearer view of where euro area core inflation is heading in the near term. The early timing of Easter this year has made travel-related services prices more volatile. Another reason is that an unexpected drop in core goods inflation has fuelled concerns over a potentially larger FX pass-through.

For all the talk about weaker economic momentum and low inflation in the euro area, we would not jump to conclusions in terms of ECB policy. True, downside risks have re-emerged over the past couple of months, generating understandable concerns and frustration in Frankfurt. However, the ECB is unlikely to respond unless those risks materialise, which is not our central case.

France’s public deficit fell to 2.6% of GDP in 2017 according to INSEE’s preliminary assessment, down from 3.4% in 2016 and below the 3% threshold for the first time since 2007. The outcome was better than the government’s estimate of a 2.9% deficit. If confirmed, France will exit the Excessive Deficit Procedure that the European Commission opened in 2009.

Today’s first batch of euro area March business surveys looks worrying at first sight. The drop in the euro area composite PMI index, from 57.1 to 55.3 in March (consensus: 56.8), was the second one in a row and the largest monthly decline in six years. New orders fell to a 14-month low. The correction in business sentiment was predominantly driven by the manufacturing sector, which could reflect broader concerns of a trade war.

Much of recent ECB dovish rhetoric has been building around the (not-sonew) idea that potential growth might be higher than previously thought, implying a larger output gap and lower inflationary pressure, all else equal. The argument is both market-friendly and politically welcome – what we are seeing is the early effects of those painful structural reforms implemented during the crisis. Inflation would be low for good reasons.

The ECB made one small change to its communication in March consistent with a normalisation process that is likely to remain very gradual. In line with our expectations, today the Governing Council (unanimously) decided to drop its commitment to increase asset purchases “in terms of size and/or duration” if needed, which had steadily become more difficult to justify and less credible anyway.

Market participants have enjoyed a protracted period of very low volatility, but it may well have come to an end in 2018. Central banks are often said to be responsible for the disappearance of volatility, for example through their large-scale asset purchases, which have compressed the term premium. But, now that the same central banks are heading for the exit from unconventional policies, they, too, need to relearn how to live with volatility.

This week the German Bundesbank published its 2017 annual report, which includes a number of interesting figures that are relevant to the broader (monetary) policy debate in the euro area. In particular, the Bundesbank provided details of the amount of securities held on its balance sheet for policy purposes, including QE, at the end of 2017, and the corresponding flows of income stemming from its asset purchases. Remember that QE is largely decentralised, with the ECB buying no more than 10% of assets itself.

French unemployment fell surprisingly fast in Q4 2017, to a new cyclical low.France registered the largest drop in unemployment in about ten years in Q4 2017. In metropolitan France, the number of unemployed fell by 205,000 to 2.5 million people, pushing the ILO unemployment rate down to 8.6% of the labour force (-0.7pp), its lowest level since Q1 2009.

Monetary policy in 2018 is all about the Phillips curve. The extent to which wage growth and inflation respond to falling unemployment will shape the monetary tightening cycle. If recent price action is any guide, any surprise on that front could result in market overreaction and volatility spikes. The most elegant description of the current state of research was provided by ECB Executive Board member Benoît Coeuré last year, who described the Phillips curve as “flatter, non-linear or mis-specified in terms of the relevant economic slack”.

Professional Forecasters survey shows a substantial improvement in economic growth and employment, consistent with the ECB’s own assessment.The ECB will be pleased by its latest Survey of Professional Forecasters (SPF). The headlines are unambiguously positive, fuelled by the uninterrupted improvement in economic data, with expectations of GDP growth and HICP inflation revised higher for the next couple of years, sometimes substantially.

German wage negotiations are in full swing amid growing calls for strikes. This comes at a crucial time for the ECB as strong growth and falling unemployment are expected to feed into higher inflation. IG Metall is by far the most important union to watch, representing almost 4 million German workers and being seen as a benchmark, including in the car industry or the construction sector this year.

We expect the ECB to announce a tapering of its asset purchase programme in the summer, but not to overreact to strong economic data. Our first choice as the title for our 2018 ECB outlook was “The courage not to act”, but regular readers will know that we used this hommage to Ben Bernanke earlier this year.

During an uneventful ECB press conference on Thursday, attention centred on the new staff projections. The headline projections were in line with expectations, albeit slightly higher on GDP growth and lower on inflation. The key word was “confidence” – in a strong expansion leading to a “significant” reduction in economic slack, as well as in the ECB’s capacity to meet its mandate.

The ECB’s meeting on 14 December would be a non-event if it were not for two specific points to make clear before the Christmas break – the staff forecasts for inflation, and the not-so-constructive ambiguity on QE horizon. We expect no major surprise from the new staff projections, reflecting the ECB’s cautiously upbeat tone.