How low inflation in eurozone could impact currency

European Central Bank head Mario Draghi says the expanding eurozone economy still faces “risks and uncertainties”— including a looming trade dispute with the United States—and has cautioned that inflation needs to rise further before monetary stimulus is ended.

Draghi said Wednesday that higher inflation, not growth, is the “very clear condition” for the central bank to end its bond-buying stimulus program, and that risks to the outlook remain. Inflation of 1.2% annually is short of the bank’s goal of just under 2% considered best for the economy.

Read: Inflation in Eurozone falls for third month

In a monthly foreign exchange report, CIBC says that, as policymakers reduce their inflation forecasts, gains for the euro could “stall until the end of the first half” of the year.

Inflation could stay low if slack in the economy and the labour market takes longer to shrink than usual in economic recoveries. Meanwhile a protracted trade conflict could hurt growth and inflation as well. U.S. President Donald Trump has announced new import taxes of 25% on steel and 10% on aluminum.

Draghi said that tariffs’ “first round effects are likely to be small.” But he warned that, after that, the “second round effects could have much more serious consequences” if the European Union retaliates, and the dispute spreads trade restrictions to other categories of goods. That escalation could in turn hit business confidence and investment.

Read: What U.S. trade tariffs mean for investors

The European Central Bank, the top monetary authority for the 19 countries that use the euro as currency, has said its 30 billion euros ($37 billion) in monthly purchases will continue at least through September, but has given no fixed end date. Annual growth has strengthened to 2.7% in the fourth quarter.

What investors should watch for

Speaking at a conference at Frankfurt’s Goethe University, Draghi echoed earlier cautious comments by saying that monetary policy needs to be “patient, persistent and prudent.” He said that the central bank would stick to its guidance on the sequencing of the next steps, meaning that the first interest rate increases will only start well after the end of the bond purchases. That would put them off until at least 2019. Currently the bank’s benchmark short-term rate is at a record low zero.

However, with Eurozone economic slack diminishing, CIBC suggests euro traders should mark two dates on their calendars: ECB staff will release revised forecasts on June 14, and the ECB will hold its Sintra symposium on June 18.

“Either of these occasions could be used to begin signalling at least a subtle shift in tone,” says the CIBC report. “Look for the common currency to begin trading stronger again in the second half of the year, and pick up pace in 2019, when rate spreads finally begin to narrow.”

Read the full CIBC report.

Also read:

Hard year ahead for U.S. dollar: Desjardins