Whatever it takes part III

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ECB President Mario Draghi further stepped up his dovish rhetoric, leaving little room for doubt that the central bank is not only about to step up its monetary stimulus, but plans to do so decisively. He made the remarks in a speech in Frankfurt this morning. Earlier in the week, the minutes of the ECB’s October meeting pointed in the same direction.

The difference in monetary policy direction between the world’s two key central banks has not been so stark for many years. Nick Kounis Nick Kounis Head of Macro Research

  • Draghi has revamped his ‘whatever it takes language’ to show commitment to getting inflation back up quickly…
  • …suggesting ECB will not only act in December, but will also be decisive
  • Meanwhile, the Fed minutes point to a rate hike next month

‘Whatever it takes’ is back

In a revamp of his famous ‘whatever it takes’ rhetoric, Mr Draghi said that he and his colleagues will ‘do what we must to raise inflation quickly’. In the summer of 2012 he used this kind of language to convince investors that the central bank would pull all the stops to protect the future of the eurozone. In the run-up to the start of QE, he revived this language to signal the central bank would be decisive in fighting deflation. Mr Draghi is once again wheeling out this language to signal that the Governing Council will take all additional measures needed to get inflation back on track to get  to close to 2% over the medium term. 

Graph: Eurozone inflation missing price stability goal

Inflation worries

The ECB President expressed concerns about the outlook for inflation, suggesting that the central bank could assess that the risks to price stability were skewed to the downside and that it would not ignore that inflation had been low for some time. There was a similar message in the minutes of the October Governing Council meeting. According the account of the meeting ‘in assessing the risks to the outlook for inflation, members noted that downside risks remained prevalent and had possibly increased’. The ECB was already projecting below target inflation in 2017 (at 1.7%) in September, so that would imply inflation would further undershoot the price stability goal.

Need to act sooner rather than later

In his speech, Mr Draghi asserted that If this picture was confirmed, the ECB would ‘act by using all the instruments available in our mandate’. The inflation outlook and risks were also clearly a worry to Governing Council members at the October meeting. At the meeting ‘members voiced concern about the prospect of a further deterioration in the price outlook’. Given this background ‘the view was put forward that a case could be made for considering reinforcing the ECB’s accommodative monetary policy stance already at the current meeting and, in any case, to act sooner rather than later’. In the end it was decided to wait until December, but to assess the potential options for further stimulus in the meantime.

Graph: ECB September staff projections

Committees to examine scale and universe of QE

At that meeting, the Governing Council also discussed the options for further stimulus. It was noted that ‘the present communication already catered for the possibility of extending the programme beyond September 2016’. However, ‘adjusting the overall size and range of eligible assets was seen as requiring further analysis by ECB staff and the relevant committees’. The Council also discussed the option of lower rates. The account mentions that ‘reference was made to the experience in other jurisdictions, where negative rates had not appeared to result in major difficulties or widespread substitution into cash’. This option would also be further examined by Committees.

Sequels never as good as the original

Like all sequels, the concern will be that the new round of actions will have less power than the last. This is certainly true in the film world, but was also evidenced in the US, with the Fed’s successive rounds of QE. However, we do think the right package can have a significant impact in reflating the economy and the fall in the euro and market interest rates suggests that the anticipation of the upcoming December stimulus is already having an effect.

The ECB’s December package

The ECB will likely be more decisive in its response than commonly thought. We expect the ECB to step up the pace of QE by EUR 20bn per month, signal that purchases will go on beyond September, and expand the eligible universe of assets to include regional bonds. We also expect a 10bp reduction in the ECB’s deposit rate and guidance that it would be cut further if necessary.

Fed meeting minutes signal December rate hike

Meanwhile, on the other side of the Atlantic, the minutes of the FOMC’s October meeting suggested the Fed was heading in exactly the opposite direction to the ECB. A majority of members support hiking interest rates next month. According to the minutes ‘most participants anticipated that based on their assessment of the current economic situation and their outlook for economic activity, the labour market and inflation, conditions for normalisation will be met in the next meeting’. However, most members are also in favour of a ‘shallow’ rate hike cycle. We expect the Fed to raise interest rates in December, but proceed cautiously after that, with the next move coming in June of next year. It is likely to be the slowest rate hike cycle in recent history.

The monetary policy chasm

The difference in monetary policy direction between the world’s two key central banks has not been so stark for many years. We think it will also have profound effects on bond and currency markets. For instance, a continued widening government bond yield spreads between the US and Germany, with new record levels for the single currency era likely to be seen before the end of this year. In addition, the EUR/USD is likely to fall significantly further.


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