The European Central Bank is speeding up the process leading up to a revision of monetary policy measures, putting the markets on alert ahead of the December meeting…
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At the very least, the asset purchase programme will be extended, as this would not require any particular revisions of the macroeconomic scenario; however, Draghi decided not to rule out the possibility of a policy rate cut, either, although we think such a move is unlikely.
Although the ECB meeting brought no particular changes to monetary policy measures, the message sent at the press conference was more accommodative than expected. Draghi indicated that the ECB has changed its attitude on data and on the choice of actions to adopt if needed from “wait and see” to “work and assess.
The change of pace and approach is justified by lingering downside risks to growth, stemming from the high level of uncertainty clouding the global scenario, which is overshadowing the fact that domestic demand remains solid. Furthermore, the ECB believes that a return of inflation towards the medium-term target laid out for the end of 2017 may be slower than indicated by the staff forecasts in September (1.7% at the end of 2017). The risk factors mentioned by Draghi include: the recent appreciation of the effective exchange rate, the trend for the oil price, and a persistently wide output gap. During the press conference, Draghi took time to dwell on the risks posed by the stronger correlation between inflation expectations (the market’s, but also those inferable from sentiment surveys) and oil prices. Therefore, the ECB will closely monitor downside risks to the inflation trend. Draghi went back to using the expression “strictly vigilant” introduced by Trichet, who typically used it to anticipate a monetary policy move at the following meeting. Although this will depend on data, and therefore there is no unconditional commitment to act, the bar that needs to be cleared to trigger new interventions has already been lowered – whereas the bar to prevent negative market reactions has been raised.
To strengthen the message, Draghi said that at the October meeting the ECB assessed all the tools it could use within the limits of its mandate, and that “there were a few members of the Governing Council who hinted at the possibility of acting” immediately. The ECB also discussed, albeit briefly, a deposit rate cut, despite the fact that Draghi had previously indicated that the current level (-0.20%) should be considered as a floor.
What actions could the ECB announce in December? First of all, the ECB could announce an extension of the EAPP to beyond September 2016, a decision that was in any case expected to come, sooner or later. This could also depend on the direction the Fed opts to take (which may already be clear on the date of the ECB meeting), and on the reaction of the markets (what mix of reactions in terms of the exchange rate and interest rates?). On the other hand, an extension of purchases should appropriately be announced well ahead of the 2016 termination date. An increase in monthly purchases that is not purely symbolic cannot be ruled out but seems less likely, as it would probably require a significant downside revision of underlying inflation estimates (currently 1.7% in 2017), and not only a worsening of the balance of risks. By contrast, Draghi did seen concerned by a potential shortage of bonds to purchase on the secondary market in respect of the capital keys rule.
We are more sceptical on the possibility of deposit rate cut to below -0.20%. The case for a cut is mostly tied to the possible effects on the currency markets, which are in fact by no means certain. Draghi mentioned that the ECB is reviewing its position on this topic, following the decision of other central banks to push official rates further into negative territory. On the other hand, the move may find a contradiction in the fact that higher costs would be imposed on banks for holding excess liquidity created by the central bank itself by means of quantitative stimulus.
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