Global Daily – See you in March

by: Nick Kounis , Aline Schuiling , Georgette Boele

140207-Global-Daily-Insight.pdf ()
  • ECB inaction disappoints financial markets, but it seems to waiting for more information
  • We think there is a powerful case for further easing and expect a move in March
  • Ending SMP sterilisation the most likely first step, but significant chance of rate cuts

ECB sat on its hands, but clear easing bias remains

The ECB kept policy rates on hold and introduced no new non-standard measures. This disappointed financial markets, that had started to price in some possibility of action over recent days. Like the majority of economists, we did not expect a rate cut this month, but we did think there was a high likelihood that it would end the sterilisation of the SMP by stopping the absorption tender. ECB President Mario Draghi spent much of the meeting defending the central bank’s decision to sit on its hands, so some of his commentary had a bit of a hawkish feel to it. In addition, he emphasised that a moderate recovery scenario was taking shape, in line with its previous assessment. However, looking beyond this, it is clear that the central bank still has an easing bias. The ECB head asserted that it remained ‘firmly determined to maintain the high degree of monetary accommodation and to take further decisive action if required’.

Governing Council waiting for more information

The reason for the ECB’s inaction seemed to be a desire to wait for more information rather than the sense that further steps were not justified. Mr Draghi said that ‘the complexity of the situation prevented action this time’ and that ‘further information and analysis will become available in early March’. There are a number of factors that the ECB wanted more information on. Firstly, more inflation data would be available next month, when the ECB staff economists would also publish their view of the inflation outlook for 2016 for the first time (usually this would not be the case until December). Second, they were keen to analyse January money supply data, because the weak M3 numbers in December may reflect side-effects from the AQR. Third, the central bank also wanted to see the Q4 GDP data, which would be released before the next meeting. Finally, it needed more time to get a clear view of the situation regarding the turbulence in emerging markets.

Powerful case for more action

We remain of the view that there is powerful case for the ECB to ease monetary policy further. Like the ECB, we do not think that deflation is the most likely scenario. However, a fresh negative shock to the economy would leave the eurozone heading for deflation given that there is currently little buffer. So from a risk management point of view, the central bank should do more to get inflation back up. Indeed, there is some complacency in the way Mr Draghi dismisses the example of Japan, because eurozone consumers are not delaying consumption and inflation expectations are well-anchored. This seems to be making an assessment of the road ahead by looking through the rear view mirror. In addition, his stated view that headline inflation is low because of food and energy does not sit easily with the fact that headline inflation sits at 0.7%, while core inflation is at just 0.8%. In addition, we think inflation will fall further. So early action would have been desirable in our view. Nevertheless, we think that the ECB will ease monetary policy going forward, with the March meeting looking to be the most likely timing. We still think the monetisation of the SMP is the most likely first step, but there is also a significant chance of policy rate reductions.

Euro and rates rise after ECB

Financial markets reacted strongly to the ECB’s non-action. Markets revised up their expectation for the profile of short rates. This led to a sell-off in eurozone government bonds. There was a relatively big move in the 5-Y segment, which is sensitive to rate expectations. The core sell-off was bigger than that of the periphery. Meanwhile, EUR/USD rallied from below 1.3500 to above 1.3615 or around 1%, before easing slightly later in the session. Finally, equity markets softened in the immediate aftermath of the press conference, but soon recovered, helped by favourable earnings.