STATE OF PLAY: Risks Grow, Inflation Weak As ECB To Meet

By Luke Heighton

     FRANKFURT (MNI) - The European Central Bank will repeat at its meeting Oct.

25 that it anticipates ending asset purchases after December, but it may

emphasise downside risks and President Mario Draghi could face questions about a

fall in underlying inflation.

     In Italy spreads have narrowed since Moody's downgraded Italian debt on

Friday, as Rome reiterated its intention to reduce the country's structural

deficit. But with S&P Global Ratings set to deliver its ratings on Friday, the

threat persists of renewed falls in government debt prices, with spillover

effects onto Italy's banks.

     These risks have emerged as heightened volatility in emerging-market

currencies and fixed income markets has assumed greater prominence in ECB

communiques. Draghi referred again to emerging-market turbulence in his remarks

at the IMF meeting in Bali, and with the Fed charting a course for successive

rate hikes at a time of a trend towards protectionism, these dangers could be

highlighted further.

     --INFLATION SLOWDOWN

     In recent remarks, Draghi also spoke of a "relatively vigorous pick-up in

underlying inflation." As the rate of increase in core prices was a

slower-than-expected 0.9% in September, he could face questions on the matter at

the press conference, although it is unlikely to affect the ECB's determination

to wind up its asset purchase programme by the end of the year or its guidance

for interest rates to remain at present levels at least through the summer of

2019. Investors expect a hike some time in the following autumn.

     The ECB will probably not give details at its October meeting of how it

will reinvest proceeds from expiring bonds in its portfolio once asset purchases

have ceased. The council is still divided over whether or not to concentrate

more purchases on longer-dated debt, and over whether to weight them in line

with new measures of national contributions to the ECB's capital, sources say.

While much of the technical work is understood to be complete, the verdict is

more likely in December, they say.

     Central bankers have downplayed the risks posed by Brexit. But as Draghi

himself recently noted, while an orderly withdrawal of the UK from the European

Union poses a limited overall risk to the euro area's financial stability, "the

uncertainty triggered by a cliff-edge Brexit could have the potential to pose a

more significant downside risk to financial stability."

--MNI Frankfurt Bureau; +49-69-720-146; email: luke.heighton@marketnews.com

--MNI London Bureau; +44208-865-3829; email: Jason.Webb@marketnews.com

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