President Mario Draghi and his colleagues in the European Central Bank Governing Council will make a decision on the contours of the extension of the current 80 billion Euro per month bond buying Asset Purchase Plan (APP) that is slated to expire on March 31 of 2017 when they meet in Frankfurt in two days’ time, on December 8.
*** The two leading options under consideration from what we understand are likely to be a six-month extension of the QE program at the current, 80 billion Euros/month pace, or a lengthier, 9 or 12-month extension, at 60 billion Euros/month. ***
*** The updated quarterly staff macro-economic projections presented on Thursday – which will include for the first time the forecasts for 2019 – are likely to contain few changes, and if anything to show a more positive, steady upward trend towards the ECB’s elusive “2% or slightly below” inflation target. But ECB officials want to wait at least until the middle of 2017 to assess whether the positive trend and recovery in inflation is sustainable before making any major changes to the “extreme accommodative conditions” supported by the options above. ***
*** A longer extension but at a lower 60 billion Euro pace would have an advantage over six-months at 80 billion Euro in clearing the German elections slated for the Fall of 2017, but ECB officials are concerned and would want to ensure that markets do not interpret any “step-down adjustment” as a premature signal of the dreaded “taper” that implies a glide path out of the QE program in the not too distant future entirely. The shorter extension would provide the ECB with the option of responding sooner to their economic projections if they pan out as expected – and so we lean if anything towards that. ***
(For background on the evolution of these options, see also SGH 10/5/16, “ECB: A Major Inflection Point,” and SGH 11/21/16, “ECB: Treading with Care.”)
*** The Governing Council will also go ahead and announce changes to the technical parameters surrounding the APP program that would ease any future concerns over the availability of the supply of bonds available for purchase under the program’s current restrictions, even though the sharp back up in yields from the July lows – almost 50 basis points on German bunds alone – dampens the urgency over the need to adjust the parameters. ***
*** These changes are almost certain to include a revision of the Collective Action Clause upper limit on bond purchases, and some flexibility and adjustment to the -0.4% negative deposit rate floor applied to bonds eligible for purchase … perhaps applying the restriction on a portfolio basis, as opposed to per issue. The ECB will also continue to allow some flexibility if needed on any specific issue purchase to deviate slightly from the Capital Key guideline, without abandoning that as the guiding driver in allocating bond purchases. ***
With a soft to stable Euro, markets where they want, and a recovery in place, even if tentatively, ECB officials will look to do no harm at this meeting, and will not take action that significantly diverges from the outline above that could upend that positive uptrend. That is all the more so in light of a 2017 that is sure to usher in a host of political risk surrounding Dutch, German, and most especially French elections.