Fra Commerzbank
At yesterday’s press conference, ECB President Draghi hinted at further policy steps at the next meeting in early December. This would confirm our forecast that the central bank will announce an expansion of QE in December, combined with open ended bond purchases. But this runs the risk of triggering an asset shortage.
To prevent this, the ECB will probably expand its purchases to other market segments such as corporate bonds. A further reduction of the deposit rate seems possible rather at a later point in time. ECB ready to do more At yesterday’s press conference, ECB President Draghi gave the clear signals the markets had hoped for: At its next meeting in December, when the new growth and inflation projections will be available, the central bank will assess whether monetary policy needs to become more expansionary.
We have long believed that the ECB’s current projections for growth and core inflation in 2016 are each about half a percentage point too high. As a consequence, we have every reason to adhere to our forecast that the ECB will use a downward revision to its projections as an opportunity to announce new steps. QE2 more likely than a rate cut But what measures will the ECB take? President Draghi did not rule out any monetary policy tools at his press conference and explicitly mentioned the option of lowering the deposit rate further – although in the first half of the year he had repeatedly emphasised that interest rates had reached the floor. Nevertheless, we regard adjustments to the purchase programme as more likely than other measures: QE2 will come!
Indeed, if the ECB now switched to using other tools, it would signal that it is no longer convinced that bond purchases are effective. This may have been one reason why the ECB emphasised in the important “introductory statement” to the press conference that the bond purchase programme “in particular” could be adjusted. In contrast, Draghi only mentioned a rate cut in the later course of the press conference. Volume up! The ECB explained in more detail that it could change the size, composition and duration of the purchases. But we would be surprised if the ECB only adjusted the composition of the purchases, as this would not change the degree of monetary policy expansion.
But according to Draghi, this is precisely what the ECB council intends to decide on at the next meeting in early December. While a change in the composition of purchases is quite likely, it would probably be a supporting measure to prevent shortage problems in buying bonds (see below). Two options thus remain for the ECB: It can increase the monthly purchasing volume from current levels of €60bn or it can officially extend its buying programme beyond September 2016. We expect it would actually prefer the second alternative – a longer duration of purchases. While an increase in the monthly purchasing volume would definitely have a stronger signal effect in the short term, this signal could quickly become negative if markets were to speculate that the supply of bonds would become tight for the ECB all the sooner, and the central bank could therefore run into difficulties with effective implementation of its programme.
That said, if the ECB does act this year, as we expect, an announcement of an extension to the programme would not change anything for the foreseeable future – i.e. for the coming months – and the important signal effect of any such decision would consequently be small, especially because most analysts and market participants expect an extension of the programme in any case. The ECB is therefore likely to accept the risks associated with a higher purchasing volume in December. At the same time, it will probably at least nurture speculation of asset purchases beyond September 2016. For example, it could delete the reference of a possible end to purchases in September 2016 and hence signal an open end to buying (“for as long as needed”).
Rate cut is possible later on
Although we still think adjustments to the purchase programme would be the most important measure, a further reduction of the deposit rate has become more likely in light of Draghi’s remarks. But just like changes to the composition of the programme, such a reduction would in our view more likely to be a supporting measure. As we have noted, if the ECB increases the monthly purchasing volume and/or extends the programme beyond September 2016, this will increase the difficulties for the bank to find enough asset sellers.
Thus the negative signal effect of possible market speculation could endanger the success of the programme. What can the ECB do to prevent a shortage of assets? A reduction in the deposit rate would be an appropriate tool: When the yields of many Bunds fell under the deposit rate of -0.2% in the spring, this provoked discussion on the markets about a further cut in this rate. The reason for such speculation was that the ECB had said that it would only buy bonds whose yields were above the deposit rate.1 If the yields of many bonds dropped below this mark, as they did in the spring, it would become increasingly difficult for the ECB to find enough bonds to buy.
If it emerges that such a development is on the cards, it will become more likely that the ECB will lower the deposit rate again. However, the central bank will probably wait initially, to be able to react later if necessary – rather than shooting all its bolts straight away. Purchases in other market segments Already before the government bond buying programme was announced, several governing council members had spoken out in favour of purchasing corporate bonds.
Against this backdrop the ECB council may indicate that it is open to changes in the composition of QE. We regard such changes to the composition of the programme as quite likely, but more as a supporting measure to prevent asset shortages. This is because from a monetary policy perspective, such a measure of itself appears ineffective: The signal effect would be quite low here too. After all, ECB representatives had always defended the need for government bond purchases with the argument that potential buying volumes in all other market segments would be too low to have sufficient effect. Moreover, purchases of corporate bonds are problematic due to their uneven distribution, and the ECB would thereby expose itself to the suspicion of financing individual companies
