ECB: The Normalization Path

Published on June 7, 2018
SGH Insight
We do not believe Praet, who as Chief Economist of the ECB sets the agenda for policy decisions at every meeting, pre-emptively flagged the discussion on whether to end QE for this meeting without the intention to signal that the decision is likely to be made and the end of the program announced this month as well.
Importantly, while the ECB is, we believe, using the window created by some stabilization in the Italian markets to pull forward the announcement on QE a bit, that does not translate into an effort to bring expectations for liftoff on interest rates closer, and into the first half, of 2019. We expect President Mario Draghi to make that point clear in next week’s press conference, as well as to stress the extreme accommodation that will still be provided into 2019 by reinvestments and by the massive ECB balance sheet. If the forecasts hold, we continue to expect the first ECB rate hike to come in early Q3 of 2019.
Market Validation
(Bloomberg 6/14/18)
Euro bulls are losing confidence.
The shared currency declined against all of its Group-of-10 peers Thursday after the European Central Bank said it would keep interest rates at current levels until at least the summer of 2019.
The euro was down 1.4 percent at $1.1632, set for its biggest one-day slide since Oct. 2017.
Bunds Rally as ECB Signals No Hike Until at Least Summer 2019
Bunds hit new session low at 159.45 on the taper announcement by ECB, but rapidly reverse decline after the ECB pledges to keep interest rates at record lows until at least the summer of 2019.
German curve steepens aggressively led by 5/30s; +2bps to 134bps
German 10y yield -3bps to 0.46%: Sept Bund futures +25 ticks to 160.32; Spain 10y -2bps to 1.39%; Italy 10y +1bp to 2.82%


European Central Bank Executive Board Member Peter Praet caught the market’s attention yesterday when he suggested the Governing Council might choose its upcoming meeting on June 12 to discuss whether to end the central bank’s bond purchasing program this year.

There is, however, still some speculation over whether the ECB will choose to formally announce their final decision on the QE program at this upcoming meeting on June 12, or wait until their next meeting in July, and on what it all means for the expected date for lift-off in rates from the current -0.4% deposit rate.

*** We do not believe Praet, who as Chief Economist of the ECB sets the agenda for policy decisions at every meeting, pre-emptively flagged the discussion on whether to end QE for this meeting without the intention to signal that the decision is likely to be made and the end of the program announced this month as well. ***

*** Indeed, any delay at this point could imply an uncertainty over the economy that simply is not there. Next week, the ECB will have in hand and review its latest quarterly forecasts, and we expect these will show a modest drop of 0.2% in GDP expectations from December’s numbers, but with the all-important medium-term inflation forecasts still on target, and largely unchanged. ***

*** Importantly, while the ECB is, we believe, using the window created by some stabilization in the Italian markets to pull forward the announcement on QE a bit, that does not translate into an effort to bring expectations for liftoff on interest rates closer, and into the first half, of 2019. We expect President Mario Draghi to make that point clear in next week’s press conference, as well as to stress the extreme accommodation that will still be provided into 2019 by reinvestments and by the massive ECB balance sheet. If the forecasts hold, we continue to expect the first ECB rate hike to come in early Q3 of 2019. ***

Italian Volatility and the ECB

The latest 30 billion euro per month round of quantitative easing has been slated to end at the end of September of this year, and with the long-awaited recovery in the Eurozone well under way, the decision to refrain this time from extending the program again has been widely anticipated.

There was, however, some question over whether that decision would be announced in June, or delayed to the Governing Council meeting in July (see SGH 3/15/18, “ECB: Defining “Well Past” on Rates”), and now Praet has brought that debate to the forefront in his remarks yesterday.

A decision in June to announce the end of the QE program would come hot on the heels of extreme volatility in Italian bond markets after the election victory and alliance between the radical 5 Star Movement and Northern League populist parties in Rome. But ECB officials, from what we understand, are relieved that the greater volatility of another round of elections at the end of July, which would have come awkwardly close to their Governing Council meeting that month, has been averted.

Furthermore, and much more importantly, they note that after some early scares, Italy’s coalition partners and new Prime Minister Giuseppe Conte have all gone out of their way to assure they do not intend to push forward on any questioning of Italy’s membership in the Eurozone.

As ECB Chief Economist, it was thus appropriate for Praet to shoot the starting gun to what has been a cautious, well telegraphed, and gradual normalization process.

Peter, the Messenger

Praet is known largely to markets as a dovish board member due to the pressure he successfully exerted on Germany’s Bundesbank President Jens Weidmann and on other hawkish Council Members in pushing through the forceful and non-conventional easing programs that have finally borne fruit in turning the Eurozone economic growth and inflation rates around.

But Praet is also perhaps the closest and most powerful ally to ECB President Mario Draghi, and coordinates both the timing and scope of policy discussions very closely with Draghi.Furthermore, he has a keen sense for driving the discussion towards consensus on the often divided, 25 member ECB Council.

This one should prove to be relatively easy.

Even with the super-charged growth rates of 2017 moderating a bit into 2018, there has been universal consensus within the Council for some time that the QE program should end this year as slated, and furthermore, that the unwind should be conducted in a gradual taper, from October to December, from 30 billion euros down to zero.

Consensus, and market expectations for the exact timing of the subsequent lift-off in interest rates from the current negative 0.4% deposit rate has, however, been more volatile. And market expectations for lift-off may be pulled forward with the announcement now of the end of QE.

But ECB officials point out that the purpose of tapering the end of the QE program through the last quarter of 2018 is not just, as publicly stated, to avert the “cliff effect” of an abrupt halt in October.

It is, also, intended precisely to keep expectations for interest rate hikes, as guided, “well past” the effective end of the program – which will be in December. And barring a shocking surprise to the upside, we still expect that “well past” guidance and the lift-off on rates to translate to no sooner than June of 2019, and to come in early Q3 of 2019.

Back to list