Fra BNP Paribas
The European Central Bank sent a signal to the markets that its quantitative easing cannot continue indefinitely at the current pace by scaling back its monthly rate of asset purchases.
It tried to limit the market impact by extending the programme to December 2017 and conveying the message that this was not the first step of a process to end it.
But flows to the market have been reduced and the maturities of its purchases can be shortened – another subtle way of reducing monetary accommodation over time, if needed. Should data evolve in line with the ECB’s expectations, it is reasonable to assume that the central bank will contemplate further reductions of its purchases in the future.
We would argue that this is indeed the start of a process, albeit very gradual, that will eventually lead the programme to an end. The European Central Bank (ECB) decided to send a signal to the markets that quantitative easing (QE) cannot continue indefinitely at the current pace, by scaling back its asset purchases to EUR 60bn per month from April 2017. We had flagged this risk, but this was not what most investors had expected (the consensus was very much for a continuation of the programme at the current pace) and, in this sense, the ECB delivered an unwelcome surprise.
The other technical aspects of the change in the programme and Mario Draghi’s comments, however, gave a dovish flavour to the overall announcement. Given movements in bonds, currency and stocks, the markets saw the move as an ease, or at least no tightening. First, according to Mr Draghi, the ECB did not taper and did not even discuss it – that is, the Governing Council did not consider gradually reducing the purchases to zero. The only other option reportedly on the table was a continuation of QE at the current pace of EUR 80bn per month. In this way,
Mr Draghi is suggesting that the decision should not be taken as the start of a process but rather as a ‘recalibration’ of the programme due to reduced risks on the economic outlook. The second key message was that the decision to scale back purchases allows the ECB to maintain a ‘sustained presence’ in the markets.
The decision appears, therefore, to reflect the trade-off between the volumes of the purchases and the length of the programme the ECB faces due to scarcity. In other words, buying at a slower pace now allows the ECB to do so for a longer period. This shows support for the ‘flow’ theory of QE benefits, in which case the full effects of today’s decision may not be seen until purchases actually step down in April. The decision to extend the programme by nine months, compared with the expected six, ties in with this message.
The ECB committed to buy broadly what the markets had expected (around EUR 500bn) but spread over a longer period. Moreover, the ECB is ready to increase again the size or the duration of the purchases if “the outlook becomes less favourable” or if “financial conditions become inconsistent with further progress towards a sustained adjustment of the path of inflation”. In a way, this is stating the obvious: the ECB already accelerated the purchases in March 2016 in view of increased downside risks.
But it is still noteworthy that it makes it explicit and does not mention the possibility of reducing the volume of the purchases if the outlook improves. The ECB preserve a high degree of flexibility with an asymmetric reaction function, as it should with subdued inflation and only moderate growth. Finally, the decision to widen the maturity spectrum of the purchases while removing the depo rate floor buys the ECB more time – the programme can continue for longer than probably many had anticipated.
Of note is that the economic assessment was changed only marginally. Mr Draghi sounded slightly more optimistic on the global outlook, which might be seen as a reason to scale back Asset purchases scaled back from April onwards A surprise to some, but with a dovish slant Only marginal change in economic assessment Not tapering Slower for longer Asymmetric reaction function 4 Luigi Speranza 8 December 2016 Macro Matters www.GlobalMarkets.bnpparibas.com asset purchases.
The staff’s forecast of headline inflation in 2019 of 1.7% was said to be not consistent with the target, thereby justifying the extension. In a way, the ECB was reducing purchases to a ‘normal pace’. After all, the ECB increased the pace of the purchases from EUR 60bn to EUR 80bn in March 2016, in view of increased risks stemming from a deterioration of the outlook for China and its impact on global financial markets. Still, the economic projections were little changed from September, with risks still described as tilted to the downside.
The ECB continues to expect headline inflation to edge higher, but mainly because of base effects, with no evidence of underlying inflationary pressure (In fact it revised down its core inflation projections by 0.2pp in 2017 and 0.1pp in 2018). This ties in with Mr Draghi’s efforts to leave the markets with a dovish message overall, despite the decision to scale back asset purchases. In sum, while scaling back its asset purchases, the ECB tried to limit the market impact of the announcement by extending the programme by more than the expected six months while conveying the message this was not the first step of a process to end it. This appears to have worked.
The market reaction has been rather limited and probably more linked to the technical aspects of the announcement (removal of the depo floor and broadening of the maturities). By pushing down short-end yields, this contributed to weaken the currency. In this respect, you could argue that monetary and financial conditions at least in the aftermath of the decision have eased or at least have not tightened, which is very likely what the ECB was trying to achieve. That said, the ECB has reduced the flow amount of monetary accommodation relative to expectations.
We see QE as affecting the economy and the markets as a result of both flows and stocks and the flows have been reduced. Moreover, the changes to the parameters potentially allow the ECB to shorten the maturities of the purchases, which is implicitly another subtle way to reduce monetary accommodation over time, if needed. Finally, should data evolve in line with the ECB’s expectations, it is reasonable to assume that the central bank will contemplate further reductions of its purchases in the future. All these effects are probably too small to have an immediate and significant impact on the markets.
But we would still argue that this is indeed the start of a process, albeit very gradual, that will eventually lead the programme to an end. With this in mind, the markets are likely to become more sensitive from now on to data evolution and other news flow. In this respect, the ECB ‘insurance’ is now less compelling, leaving peripheral bonds more exposed to political developments and idiosyncratic risk, in our view
