ECB: The Upcoming Ease

Published on July 12, 2019
SGH Insight
We understand ECB officials are, for now, still leaning towards the September 12 meeting to announce an ease.

Waiting until September, the current thinking goes, would allow for quarterly forecast revisions, and it would afford the ECB more time to assess the most recent data, including specifically the extent to which the manufacturing slowdown to date has been feeding through to consumer and other sectors. The July meeting will at a minimum nevertheless provide an occasion for Draghi and ECB officials to further firm up their communications and forward guidance, perhaps in revising their already extended commitment to “low rates” to include “or lower rates,” and most certainly to hammer home the ECB’s new-found emphasis on a “symmetric” 2% target for inflation.
Market Validation
(Bloomberg 7/25/19)

ECB Signals Rate Cut, QE as Global Stimulus Push Picks Up
Governing Council changes policy language to prime for easing
U.S. Federal Reserve widely expected to lower rates next week

The European Central Bank sent its strongest signal yet that monetary support for the euro-area economy will be stepped up after the summer break, with lower interest rates and renewed asset purchases on the table.

President Mario Draghi and fellow policy makers said on Thursday they expect borrowing costs to stay at present levels “or lower” through at least the first half of 2020, opening room for a September reduction in the deposit rate from the record low of minus 0.4%. Officials also signaled they will restart their bond-buying program if needed.

Germany’s 10-year bond yield dropped to a record-low minus 0.42% and the euro slid 0.3% to as low as $1.1108. Bank shares rallied as policy makers said they’ll consider measures to offset the squeeze on lenders’ profitability from negative rates

With Federal Reserve Chair Jay Powell in effect all but guaranteeing an interest rate cut at the Federal Open Market Committee’s upcoming meeting on July 30-31, markets have in parallel brought forward expectations for a rate cut by the European Central Bank from its Governing Council meeting in September to July.

** Our most recent soundings, however, indicate ECB officials have yet to determine the exact shape and degree of stimulus needed for the Eurozone. So with a significant caveat that ECB President Mario Draghi may indeed push for a cut as soon as the July 25 meeting — perhaps to preempt a pop in the Euro — we understand ECB officials are, for now, still leaning towards the September 12 meeting to announce an ease.

** Waiting until September, the current thinking goes, would allow for quarterly forecast revisions, and it would afford the ECB more time to assess the most recent data, including specifically the extent to which the manufacturing slowdown to date has been feeding through to consumer and other sectors. 

** The July meeting will at a minimum nevertheless provide an occasion for Draghi and ECB officials to further firm up their communications and forward guidance, perhaps in revising their already extended commitment to “low rates” to include “or lower rates,” and most certainly to hammer home the ECB’s new-found emphasis on a “symmetric” 2% target for inflation.

** While the concept of a “symmetric 2% target” has, under current and continued inflation misses to the downside, met with little opposition in public from ECB officials, it represents, truth be told, a bit of mission creep in the evolution of the ECB’s target. That started as “below 2%,” went to “below but close to 2%,” and has now been restated as “symmetric around 2%.” ECB officials believe that target “refinement” has yet to be fully appreciated by consumers and wage setters, nor by certain National Central Banks and the financial markets.

** As to the shape of the next ease, indications continue to be that the Governing Council is leaning heavily towards a further cut in the negative deposit rate from the current -0.4%, with a likelihood that a resumption of the “Asset Purchase Plan” bond purchases, a more complicated endeavor, will be left in the back pocket for a scenario that truly requires, in Draghi’s famous words, “whatever it takes.”

** A cut in the deposit rate will be accompanied by “mitigating measures” for banks, that will, it appears, be allowed to keep a larger portion of their deposits at the ECB at less punitive rates. While market expectations revolve around a modest, 10 basis points cut, these mitigating measures could, in theory at least, open the door for deeper cuts if needed either in September, or further ahead.

** Regarding bond purchases, ECB officials have gone to great lengths to emphasize that the existing 33% limit on sovereign bond ownership is self-imposed, and could be revised upwards. But that limit, in a compromise struck with Germany, was based on a principal of “proportionality” expounded by the European Court of Justice, under which the ECB was given the green light to adopt new monetary policy tools.

** In practice, that means if the ECB were to attempt to change those parameters, they would need to be prepared to make the case for why that was truly necessary. While making that case is eminently doable, it does play into practical considerations of just how much stimulus can be afforded through net new purchases under the current parameters, versus the political lift of raising the sovereign bond issuer purchase limit from the existing 33% to, say, 40%.

** The ECB could focus on purchasing proportionately more packaged bank loans and corporate bonds – which have been growing in market size — than on the more limited sovereign bond purchases. But without a bump in the sovereign limit, that would still only afford a modest stimulus at best. And even then, the stock of German debt has been shrinking in absolute terms, and the ECB is already at roughly 40%, for example, on supra-nationals such as European Stability Mechanism debt, which has a higher 50% cap.

** Finally, the ECB will continue to reinforce the importance of a helping hand from the fiscal side, and the heightened calls from the ECB for additional stimulus from countries that have the fiscal space to do so. That is a theme that has most recently been hammered home yet again by the International Monetary Fund, and which will be sure to continue to feature prominently as IMF Managing Director Christine Lagarde takes the helm of the ECB from Draghi in November.

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