09 Dec 2016

ECB reaction ­- Easing not tapering...

Philip Shaw

Chief Economist

Today’s Governing Council (GC) meeting agreed to extend the QE programme beyond the existing end-point of March 2017 by nine months to December 2017.

The additional monthly purchases however will be conducted at a pace of €60bn per month, a step down from the current rate of €80bn. The GC added though that a set of less favourable economic or financial conditions would be met by an increase in the size or a lengthening in the duration of the programme. Meanwhile official ECB rates were left unchanged i.e. the deposit rate at -0.40%, the refi rate at 0.0% and the marginal lending rate at +0.25%. Markets (including ourselves) had expected rates to remain on hold but had thought the ECB would leave the Asset Purchase Programme (APP) running at €80bn per month for a further six months.

Markets were confused as to whether the new QE plan was a way of tapering the purchases. On this point Draghi was definitive. He stressed, with some justification, that tapering would include a plan to reduce purchases to zero at some stage and that this option was not even ‘on the table’. Also, he pointed out, the extended period would help to convince investors that the ECB would be a sustained presence in the markets. He stressed that that the GC could decide to step up or extend purchases in the APP.

In addition the GC announced that it had voted in favour of relaxing two criteria to buy sovereign bonds. First, the minimum maturity is to be lowered to one year from two. Second, that when necessary, central banks will be able to buy paper yielding below the deposit rate. These changes are in order to alleviate potential shortages of assets. There will also be some relief from the reduction in monthly purchases to €60bn in April. It should be noted though the rise in yields over the past couple of months will in itself widen the pool of eligible bonds.

There were relatively few changes to the staff forecasts. The outlook for GDP remains relatively lacklustre by historical standards, slowing marginally from 1.7% this year and next, to 1.6% in 2018 and 2019. We note that the HICP inflation projection for 2019 is 1.7%. When asked whether this was compatible with the ECB’s target of ‘below, but close to 2%’, Mr Draghi replied ‘not really’, although he declined to be specific as to how much of the easing announced today had been embodied into these forecasts.

The introductory statement continued to make a reference about the risks to the economy being tilted to the downside. That said, the narrative as a whole seemed to exude a firmer tone. There was a reference to the recovery proceeding at a ‘firming pace’, a term not used in October. A phrase noting ‘improvements in corporate profitability’ was also added. And the statement added observations of a ‘somewhat stronger global recovery’. Indeed at the press conference, Mr Draghi stated that the risk of deflation had largely disappeared.

Inevitably, given the weekend’s ‘no’ vote in Italy, the subject of the Italian banking system was raised. The ECB President faced a question connected to stories suggesting that troubled bank Monte dei Paschi di Siena has requested more time to complete a recapitalisation. Mr Draghi skipped this one, referring the questioner to the ECB Supervisory Board. Later though, he did concede that he knew ‘very little’ about a rumoured loan by the European Stability Mechanism (ESM) to the Italian banks. This suggests perhaps that the stories carry some credibility.

Overall today’s events clearly show that the ECB remains in easing mode. The point did have to be made. With ‘core’ inflation still below 1% and moving sideways, it would be difficult to claim that inflationary pressures are on the rise. However there might been some questions that the GC’s reaction function was shifting – e.g. it was becoming more concerned over bond shortages or unintended consequences of expanding its balance sheet. Mr Draghi has killed off all such speculation and it is clear that the ECB remains in easing mode, despite its more upbeat assessment.

Following today’s decision we now expect the ECB to begin to taper its programme in a year’s time (rather than in September). And on the back of that change, we have pushed back our forecast of the first hike in the deposit rate by three months to June 2019. Of course, this remains highly uncertain. But we maintain that the ECB will avoid bringing its key rates down again from current levels.

As mentioned earlier, markets were uncertain how to read today’s announcements. The euro initially made sharp gains, while sovereign bonds suffered a general sell-off. However it became clear that this was not a taper and the euro fell back to $1.06, 2½ cents below the highs of the day. Short bonds rallied, given that the ECB will now be buying bonds of 1-2 years’ maturity. Longer-dated paper recovered some of their losses but yields ended up on the day, perhaps as investors fear that purchases of shorts will displace those further up the curve. Stocks were less equivocal, rallying strongly by close to 2% in the case of the Spanish Ibex.