ECB: Draghi Deciphered

Published on September 8, 2016

Initial headlines after today’s Governing Council meeting that the European Central Bank had decided “against” the extension of its bond buying program could not be more misleading and further from the truth.

With little urgency and six months to go still until the March 2017 end date for the current QE program — and on the heels of a slow August holiday no less — there was no doubt little chance for the ECB staff to evaluate and present complicated technical decisions in time for this meeting. Instead, we supect it will probably take at least another meeting if not two to map out the technical issues and to go through the merits for an extension of the QE program and the related actions on the policy decisions we have been expecting the ECB to take (see SGH 8/1/16, “ECB: Easing without Cutting”).

Here is what we believe are the two key points from today’s presser:

First, the ECB will extend its bond purchase program beyond March 2017.

Even though President Mario Draghi backed away from making a formal extension announcement at this press conference, he went as far as he possibly could without a formal Governing Council decision yet made to validate those expectations. The ECB has already committed to purchases beyond that date if necessary, and in “any case” will keep buying as long as needed to meet its inflation mandate (or, more precisely, to be on target to meet its mandate).

Draghi stressed that even though the drag effects on inflation from low energy prices might be receding – very slowly – the underlying inflationary impulses are still extremely and dangerously weak, and indeed, the ECB forecasts are contingent on expectations of continued “exceptionally” supportive monetary conditions.

And despite some chatter in the press about resistance to an extension of the QE program from ECB hawks, there is “unanimous” commitment to hitting the ECB inflation target. Indeed, if there is any hesitation or compromise at all between doves and hawks needed on the extension of the ECB program, we believe it will come through a compromise on the length of the extension rather than a debate on whether to extend the QE program at all; we likewise think it highly unlikely the 80 billion Euro monthly purchase pace will be tapered.

Second, we continue to believe the ECB will amend restrictions on purchasing bonds yielding below the -0.4% deposit rate as the main revision to the current QE program.

That decision, of course, will only come after the committees tasked today to study the technical issues come back with their study of various options. But that seems the most likely option the ECB will turn to order to expand the universe of bonds eligible for purchase for an extension of the QE program.

Draghi was very careful today not to pre-commit to any option or decision on how to more effectively implement the current QE program, indeed stating that all options will be considered. That does mean leaving open the potential for a switch from the ECB Capital Key guide for bond purchases to a market capitalization or size-based approach.

And there has already been a very small, de facto drift away from a strict purchase program based to the capital key for practical purposes with little controversy or fanfare. For example, Estonia has run out of bonds to sell, and the ECB has had to marginally tweak and reallocate purchase quotas among other countries and asset classes.

But we do not expect the ECB to embrace a wholesale upending of the capital key criteria for a market-based one. Indeed Draghi noted that the current program was limited by “current market rates” and by the “new constellation of interest rates.”

Rather, we still believe the Governing Council consensus will continue to build for the ECB to revise the restrictions on purchases of bonds yielding lower than the negative 0.4% deposit rate.

As we also wrote previously (again see SGH “ECB: Easing without Cutting”), the ECB can, and we expect will, also raise the 33% self-imposed limit on the purchase of highly rated bonds as a complementary, albeit much smaller, measure for expanding the universe of bond purchases. We believe that would, however, likely be limited only to AAA, or similarly ultra-high, credit rated bonds.

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