Fra Commerzbank:
Last Friday, ECB president Draghi delivered a clear signal that the Governing Council will further open the monetary floodgates at its meeting next week. We still believe that additional asset purchases will be at the core of the measures. Furthermore, on the basis of Draghi’s statements, the deposit rate may be lowered slightly.
The ECB will therefore probably meet market expectations. Moreover, it should hold out the prospect of further measures in the event that it has to revise its inflation and growth projections downwards again. QE volumes to the fore … “We will do what we must to raise inflation as quickly as possible!“
Given these clear words from Draghi, there is much to suggest that the ECB will ease monetary policy again this coming Thursday despite surprisingly positive sentiment indicators of late and a slight rise in the core inflation rate. Draghi is focusing “in particular” on the asset purchase programme (QE).
This is a “powerful and flexible instrument, as it can be adjusted in terms of size, composition and duration to achieve a more expansionary policy stance”. Any concerns about negative side-effects have not yet been confirmed. It would thus be surprising if the ECB decided not to use this instrument after Draghi expressly emphasised its effectiveness in his speech. In our view, it is fairly likely that the ECB will delete the reference to “September 2016”, and stress instead that the purchases will be made “for as long as necessary”.
The ECB staff forecasts for core inflation in 2016 and 2017 are likely to be reduced (Table 1) which is an argument in favour of purchases being continued for longer than expected so far. However, such an extension implies that monetary policy will in effect only become more expansionary next autumn and will have no effect on inflation in the near-term.
We have therefore been predicting for some time1 that an increase of the monthly buying volume is likely to be the core measure in December, as it is only as a result of such an increase that the degree of monetary expansion can be achieved immediately. … and a somewhat lower deposit rate Another reduction in the deposit rate from a current level of -0.2% to somewhere around -0.4% is likely in view of what Draghi said last Friday.
The ECB president argued that a lower deposit rate could increase the efficiency of QE. He thus confirmed our long-held view that a rate cut by the ECB only appears to make sense as a supporting measure to QE.2 That said, we still expect an even lower deposit rate to have negative side effects. In Switzerland for example, the (strongly) negative key interest rate led to a rise in lending rates.
If the ECB decides in favour of a rate cut nevertheless – despite the fact that ECB representatives never tire of stressing the importance of continually falling lending rates in the euro zone – this could be because Draghi and other supporters of major steps want to put together a comprehensive package of measures to impress the market.
However, as they do not have a majority for their preferred strong expansion of QE volumes, they might resort to a further rate cut which is easier to implement. Support for such an interpretation can be found in a news agency report which suggested that four unnamed ECB Governing Council members emphasise that there is a consensus in the council for a lower deposit rate, as this is the least contentious measure
The devil in the details It is quite possible, however, that the council will merely make a decision in principle on Thursday and defer the clarification of further details to a later meeting.
• Allowances at negative rates: If the ECB lowers the deposit rate further, as we expect, it would be likely to introduce allowances, i.e. no penalty interest would have to be paid on a part of the surplus liquidity. In countries with a strongly negative key interest rate (Switzerland, Denmark) this is already the case. The introduction of such allowances would be a further indication that the ECB primarily wants to weaken the euro further to stimulate the economy and increase the inflation rate.
Indeed, the reaction of money market rates, and thus also of the euro, would not be influenced by such an allowance; what would be decisive is that banks are affected by the higher “penalty interest” on part of their surplus liquidity – not necessarily all of it – and would therefore look for a more attractive (or less unattractive) investment opportunity. Consequently, the ECB can weaken the euro with an even more negative deposit rate by introducing allowances and at the same time limit the negative side-effects; the costs for the banks would not rise as sharply and they would consequently increase their lending rates to a lesser degree and would be less likely to demand a negative deposit rate from their clients.
On the other hand, if it were the central bank’s objective to stimulate lending with a lower deposit rate, as ECB president Draghi signalled last Friday, the ECB should avoid high allowances; this would mean banks would incur high costs by holding surplus liquidity which in turn would increase their incentive to reduce surplus liquidity by granting additional credit. Clearly, the introduction of allowances would be counter-productive if the strategy is aimed at boosting lending.
• Additional purchase of regional government bonds: We believe that besides a higher volume and longer duration of purchases, the ECB will opt for several changes to the composition. For example, regional government bonds could be included in the Public Sector Purchase Programme (PSPP), which would somewhat ease shortage concerns for Bunds. It is also possible that corporate bonds could play a role in future. The signal is what counts The ECB’s main objective is which has already weighed on the euro. Furthermore, the financial markets are much less unsettled about the situation in China and sentiment indicators have surprised on the upside again recently. In addition, the core inflation rate has picked up a bit recently to 1.1% (although it should fall again to 1.0% in November).
• The strategy of large steps has so far only been successful to a limited extent. Bond yields have risen significantly over the year and the euro also subsequently appreciated following the announcements at the start of the year. Furthermore, in the current situation, the ECB has to be concerned that in the case of another large package of measures, speculation will arise that the central bank has essentially shot all its powder because the lower bound for interest rates has been reached and/or there are now scarcity problems with asset purchases. Risks of forecast are evenly spread According to agency reports, some 20 different packages of measures are being discussed at the central bank. All in all, the risks that the ECB will exceed our expectations or act more cautiously are, in our view, evenly spread:
• The surprisingly clear negative stance of some Governing Council members and the recent surprising data on the positive side could lead to the package of measures falling short of our expectations. It would be unclear though why ECB president Draghi reaffirmed market expectations on Friday if he was not certain beforehand of a solid majority in the Council.
• Even if ECB projections are revised downwards, as we expect, they are still probably much too high. Should the ECB correct their estimates more sharply to the downside, a larger package of measures would then also be more likely. Euro and yields to fall further We stick to our forecast that the euro will depreciate further towards parity with the dollar amid diverging monetary policies in the euro zone and the USA. How quickly the euro will retreat in the near term will depend on how convincingly the ECB manages to convey the message of possible further steps.
Yields should fall further initially on account of the package of measures and the prospects of more to come. probably to achieve the strongest possible effect on the markets. To do so, the markets must be convinced that the ECB is doing all it can to achieve its inflation objective – only then would the financial markets be expected to react by driving money market rates and the euro lower on a more sustainable basis rather than simply as a kneejerk response.
One way of sending out such a strong signal is the strategy followed by the ECB at the beginning of the year when it announced the current asset purchase programme and exceeded market expectations with the announced monthly purchase volume. The alternative is to more or less meet market expectations with the measures but also announce further steps in the case that its objectives run the risk of not being achieved.
We believe the second strategy is more likely: • We anticipate that the ECB will not revise its projections downwards massively, which argues against a more significant step.
• In the past few weeks, a serious minority of ECB Council Governing members (Lautenschläger, Weidmann, Knot, Jazbec, Hansson, Rimsevisc) have spoken out quite clearly against further steps.
• Some of the reasons given for further measures at the last Governing Council meeting in October are no longer very convincing: an interest rate rise by the Fed is all but certain,
