ECB: all options are open. A refi rate cut to 0.10% in March cannot be ruled out, should data surprise on the downside. From March the ECB will be publish two-year ahead forecasts and will thus signal that the ECB’s monetary policy will…
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remain accommodative for longer than the Fed’s and the BoE’s. Draghi opened to the legal admissibility of a standard QE to counter the risk of deflation, but we continue to believe this would be an extreme measure. The Karlsruhe has remitted to the European Court of Justice the final say on the legality of the OMT, this should clear the way for the facility and indirectly lowers the hurdles for a QE program in the euro area.
The ECB confirmed its forward guidance and the commitment to take further decisive action if needed. The tone of the communication was in our view significantly more accommodative than markets’ reaction suggested. The EUR shot up to 1.362 from 1.3531 at the beginning of the press conference. Two-year rates on the Bund and on peripherals rose by around eight basis points. The refi rate cut, expected by the market already this Thursday, may come in March, but much will depend on the evolution of the growth scenario. Draghi specified that the Council considered the information available at this meeting incomplete, and will therefore await further data to assess the progress of the recovery in the euro area, and to verify whether the inflation surprise is confirmed. There were a few important developments during the press conference.
1) The ECB is openly concerned about the risk of an extended period of disinflation. Revisions to inflation estimates for 2014-2015 in March cannot be ruled out, although for the time being Draghi has not made them out to be very likely;
2) the ECB will maintain an accommodative stance longer than the FED and the BoE. While this was widely expected, it will in some way be made official in March, when the ECB will publish its growth and inflation outlook up to 2016, therefore tying guidance to a medium-term inflation forecast. In our view, the ECB’s forecasts for 2016 will point to an inflation rate still significantly lower than 2%, and to euro area GDP growth of 1.6%-1.7% at best, therefore signalling the ECB’s intention to keep monetary policy accommodative for longer than the FED and the BoE;
3) Draghi showed openness on the legality of QE in countering the risk of deflation. The ECB may consider purchasing a basket of euro area bonds with weights determined by country key in ECB capital, so as to signal that the operation is in some way “country neutral” and aimed solely at countering the risk of prolonged deflation/disinflation. Draghi also added that an asset purchase programme should not be considered as illegal, in much the same way as the SMP wasn’t. A programme for the purchase of government bonds would not be in conflict with OMTs, as OMTs are designed to counter the risks to price stability generated by redenomination risk tied to the exit of one of the member states from euro;
4) Draghi indicated that the ECB’s main concern is the dynamic of lending to the private sector, and referred once again to an ABS purchase programme as a possible way of alleviating the issue. For the time being, a programme to purchase equity is ruled out.
On the whole, we continue to believe the ECB’s moves will be guided by the evolution of the growth scenario, as once the recovery consolidates, the risk of prolonged disinflation should also wane somewhat. In a cyclical recovery phase the ECB will reasonably want additional evidence that the current trend of inflation under 1.0% may continue for an extended period, yet the ECB in Draghi’s words is not cool about the recent decline in inflation and could take pre-emptive action. In the weeks ahead, it will be appropriate to monitor: i) the trend of the exchange rate; ii) the emerging markets’ crisis; iii) business surveys; iv) price indices included in the monthly surveys of businesses and households; iv) market expectations; v) real data releases (December industrial output and 4Q 2013 GDP due out next week).
We continue to believe that in case of growth and inflation surprises, the sequence of moves, in order of probability, could be: i) a 15 bps refi rate cut in March, with the deposit rate untouched; ii) removal of SMP sterilisation; iii) a new longer-term refinancing operation; iv) introduction of a credit easing programme, although given its difficult implementation and the legislative and regulatory differences within the euro area, the ECB may opt for a programme for the purchase of government bonds weighted by the share held by each member state in the ECB’s capital.
Appendix
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