We expected the European Central Bank (ECB) to be dovish during Thursday’s policy meeting (in line with the downturn in the global environment since the start of 2016), but ECB President Mario Draghi has gone further than anticipated.
Draghi indicated that the policy stance ‘will need to be reviewed in March’, and ‘potentially has to change’. Given this came within the initial minutes of the opening statement – and was not buried in the Q&A – we believe the ECB wanted to send a clear commitment to its willingness to do more easing. Given that the last ECB minutes pointed towards a 10bps deposit rate cut being the most likely tool of choice, this could be seen as a pre-commitment. There was unanimous agreement on this statement – and given it was the divergence in ECB Governing Council views in December which led to the market disappointment – we view this as an important development.
Why does the policy stance need to be reviewed and potentially changed? Conditions are significantly different from early December. We believe the ECB is seeking to maintain its credibility by citing global economic conditions. While the Eurozone recovery is expected to proceed, the risks associated with China, EM and financial markets have grown and pose risks to Eurozone growth. The 2016 inflation path will be ‘significantly lower’ and perhaps even negative – with oil now 40% lower since the cut off for the last set of ECB projections. Draghi rejects that the ECB should ignore the impact of oil on headline inflation given how close inflation is to zero and that second round effects (particularly of lower inflation expectations) are already occurring. Finally, Draghi asserts that the credibility of the ECB would be harmed if they didn’t respond to new incoming information.
Focus for the March meeting will be: just how much is inflation downgraded in 2016, where 2018 inflation is forecast and what the easing actions will be. We expect a 10bps deposit rate cut, and we will have to watch communications to see if changes to QE are likely. By far the most likely QE change would be a further (and perhaps final) 6 month extension to September 2017. After this point, the ECB will run out of assets to buy if they don’t change the capital key – and that seems unlikely without Eurozone growth falling significantly or a removal of the 33% issuer limit. A positive surprise would be an increase in the monthly amount purchased by the QE program.
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