ECB Remains Firmly On Hold

Yesterday the European Central Bank (ECB) left all policy rates on hold and released details of their policy stance, as outlined at the previous meeting. The details of the asset purchase program are as follows (from Barclays):

“The purchases will be conducted in the primary and secondary markets, but no primary market purchases will involve debt instruments issued by entities that qualify as public undertaking. They will include all non-bank entities above a certain credit rating (BBB-), including insurance companies. The risk will be fully shared by the Eurosystem. It includes up to 30yr maturities. Similar to the CBPP, the Eurosystem will apply an issue share limit of 70% per ISIN. President Draghi did not mention the size of the monthly purchases but only said it would contribute to the €80bn of monthly asset purchases.”

In our opinion, these details are not important, but rather logistic, from a macro point of view. What is important is that the ECB is totally comfortable with its current policy stance despite the stated downside risks. Furthermore, without a shock to the system, markets must be patient and wait for the pass-through of their policy. ECB President Mario Draghi said:

“Our policies work, they are effective. Just give them time. Our policies are the necessary policies for return of the inflation rate to our objective of at or just below 2% and return of interest rates to higher level than today.”

“When we have low inflation for a long time, which we will, we should be patient…”

Our views:

The currency is not too strong

Euro$ has moved upward as of late, and the ECB did not take the opportunity to talk it down. Therefore, we haven’t seen their breaking-point, or the ECB’s upper limit. From a market point of view, 1.17 seems to be an important support level – I suspect that the ECB would be uncomfortable with the levels euro$ could reach if it breaks out.

Watch core inflation

The ECB expects inflation to turn negative later this year; but in theory the credit channel and the economy should continue to reap the benefits of their policies, thereby supporting inflation ex energy/food. In my view, there’s not sufficient economic support for core inflation not to stabilize or even fall later this year. 

Does the ECB have the ability to generate sufficient wage and price inflation in a weak labor market when the US economy cannot do it within a framework of arguably full employment?

No new measures on the horizon

There were no discussions around helicopter money (the market’s latest craze) or equity asset purchases. In our view, only an economic deflationary reality that is far away would result in these measures. On balance there is not much new here from our standpoint. The ECB is on hold, and it would take a new negative shock to the economy or a material undershoot of late-year core inflation to add conviction on the need for new policy initiatives

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