Global Daily – ECB scenarios

by: Nick Kounis , Georgette Boele

140206-Global-Daily-Insight.pdf ()
  • We expect the ECrB to end SMP sterilisation, which should push down rates and the euro…
  • …there are other alternatives with various scenarios for markets
  • Meanwhile, there was a decent job gain in the ADP report, despite a hit from the weather

Over recent days, financial markets have started to price in the possibility of ECB action today. We look at some of the possible outcomes and the market impact below.

No action, just more talk

If the ECB were to leave money policy unchanged without changing the forward guidance or providing a clear signal that easing will follow in March, this would clearly disappoint. Financial markets will build in higher short rate expectations, government bonds would sell-off, led by the periphery, and the euro would strengthen.

Stopping the sterilization of the SMP

An ending of the absorption tender used to sterilise the SMP (the now dormant bond purchase programme) is our central scenario. It would more than double the excess liquidity in the system, which would lead financial markets to re-evaluate the pressure on interbank rates from money market tightness both currently and in coming months. It would therefore depress short rate expectations, provide support to government bonds – especially the 5Y – and put downward pressure on the euro. It might also have the indirect effect of making investors judge that a quantitative easing programme (unsterilized asset purchases) had become more likely at some point in the future, which would be supportive of peripheral bonds (see below).

Policy rate cuts alone or together with SMP monetisation

Few analysts expect rate cuts today, but it is probably a closer call than that suggests. We think the SMP monetisation is the more likely action, but there is also a serious possibility that the ECB cuts its policy rates either as an alternative or a complement to such an action. We think that if the ECB did decide to cut rates, it would not want to narrow the corridor any further, so would also likely cut the deposit rate into negative territory. A smaller than normal reduction (-10bp) would be likely as the central bank would want to test the water. Such a move would lead to a depression of short rate expectations, steeper curves, peripheral compression and a fall in the euro. A negative deposit rate in tandem with SMP monetisation would amplify these effects and could anchor the EONIA rate and rate expectations very close to zero.

Quantitative easing

The announcement of a large-scale QE programme is a very low probability event at this stage. The economy would probably need to relapse for such a tool to be employed. Despite the controversy, in this scenario, we think the only real option would be government bond purchases. Obviously all eurozone government bonds would benefit in the near term (with the direct effects depending on the exact design and scale), but search for yield would ultimately benefit peripherals. Over time, the core could eventually suffer because of higher expectations of future growth and inflation. The euro would fall off a cliff.


Decent job gain in ADP report, despite hit from weather

US private employment rose by 175K in January, following a downwardly revised 227K gain the month before (originally: 238K). Although the outcome was slightly below the consensus forecast of 185K, ‘cold and stormy winter weather continued to weigh on the job numbers’, suggesting that we would have seen a higher number had the weather not been unseasonably disruptive. In addition, average private employment growth ran at 230K in the past three months, implying that the labour market recovery is in any case slowly gaining traction. Although from month to month, there can be large deviations between the ADP and official numbers, the report does point to some downward risks to our forecast of a 200K gain in Friday’s nonfarm payroll figures.