ECB: The December Governing Council Meeting

Published on November 19, 2018

Investors have been paying close attention to speeches by European Central Bank officials in the run-up to the December 13 Governing Council Meeting, scouring for signs of how they may adapt their currently telegraphed 2019 exit strategy to some of the recently heightened downside risks perceived by the markets.

Here is a guide to what to expect for the December 13th ECB meeting, with details on each bullet below:

  • QE will end and there will be no changes to rates guidance;
  • The existing Capital Key may, from what we understand, be maintained for a two-year transition period specifically for the reinvestment of bonds, which would keep favoring Italy over Germany as opposed to reinvesting according to the new 2019 Capital Key;
  • Any discussion over a new TLTRO program for banks will be pushed to the spring of 2019, views remain divided, and a new program is far from a given;
  • Downside risks are likely to be increased, growth forecasts tweaked down, and inflation forecasts for 2019 tweaked slightly upwards, then tailing back down in 2020, primarily due to the current drop in oil prices.

Ending the QE Program/Rates Guidance

Barring a surprise of truly seismic proportions, the current QE program will, as planned, officially be brought to a close in December – meaning no net new bond purchases by the ECB, but continued reinvestments of bonds maturing on the European and National Central Bank balance sheets (see below). Op-eds and speculation to the contrary, you can take that one to the bank.

Similarly, there will be no change at the December meeting to the ECB forward guidance on liftoff, (“We continue to expect them [rates] to remain at their present levels at least through the summer of 2019, and in any case for as long as necessary to ensure the continued sustained convergence of inflation to levels that are below, but close to, 2% over the medium term”).

That language remains perfectly well-suited to the current outlook, and adaptable to changing conditions should it be needed. While there has been some back and forth between members wishing to fine tune market expectations, any such discussion on rates guidance now at the Governing Council level is premature.

Bond Reinvestments and the Capital Key

Apart from greenlighting the end of new purchases, the December 13 meeting will need to address the technicalities (“modalities,” in ECB speak) surrounding the reinvestment of bonds going into the new year and beyond.

From what we understand, there is little room or interest in playing around with the duration of reinvestments. The real policy decision instead revolves around whether reinvestments are conducted according to the existing “EU Capital Key” country proportions that has been used through the QE program, or according to a new Capital Key that will be recalculated for 2019 and beyond (reviews are conducted every five years, or when large members join, or leave, the EU).

The new Capital Key, reflecting mainly GDP growth changes since the last Capital Key calculations, will include more Germany and, for example, more Netherlands, but less Italy. That pro-cyclical change, while not enormous — a change of around 1-2 billion Euros here and there — is still exactly the opposite of what those respective domestic economies actually need.

From what we understand, the Governing Council may settle on a compromise to retain the current Capital Key proportions for two years where it comes to reinvestment of bonds purchased under the expiring QE program in order to address those pragmatic considerations, and then phase in the new Capital Key on the remainder of reinvestments after that.

Bank Loans and TLTROs

Some banks and analysts have also been clamoring for a potential new TLTRO (Targeted Long-term Refinance Operation) or LTRO, to provide emergency-level funding to banks as the existing loans roll off, and ECB officials themselves appear somewhat divided on the desirability or need to reinstitute that program again. Those questions were in fact raised by two Governing Council members at the last ECB Governing Council meeting on October 25, and revealed by ECB President Mario Draghi in the subsequent presser.

But a decision on a potential new TLTRO program, from what we understand, will not be made at the December 13 meeting, but left for spring of 2019, allowing the ECB to assess the economic conditions then at hand.

While banks have been asking for clarity this year, the existing programs do not run out until 2020, and a critical issue for reaching a Governing Council consensus when it does decide on the fate of the TLTRO programs will be whether a new program would be simply intended to help one or two countries’ banking systems (e.g. Italy), or whether it would be needed for the broader transmission of monetary policy through the Eurozone, the latter being much more clearly within the ECB mandate.

As things stand, we would not take it for granted that a new program will be introduced in 2019.

The Economic Forecast and Risks

Finally, on the economic forecast itself, the ECB will acknowledge some increased downside risks and nudge growth forecasts down a tad, although some of these risks may or may not be any clearer even by then.

The ECB sees these risks, as before, to include the US trade fight with China, but also the possibility of a re-escalation of the Trump administration’s auto tariff threats against the EU that have been put on hold. They also include potential contagion from Italy, a broader, cyclical global deceleration, and the fall-out of a hard Brexit on the EU and Eurozone should negotiations with Westminster fail.

On the other hand, when it comes to the all-important inflation forecast, 2019 is likely to be nudged slightly higher, if anything, while 2020 could drop down a little. That is due to the latest sharp drop in oil prices that is expected to show up in year on year comparisons for late 2019 and early 2020.

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