Macro Weekly – ECB warms to QE

by: Han de Jong , Nick Kounis , Roy Teo

Macro Weekly - 7 April 2014 ECB warms to EQ.pdf ()

Big Picture: Key central bankers are trying to find the right balance as the economy is gradually showing its real trend after months of distortions. The picture is favourable, perhaps even a Goldilocks scenario: the US economy is growing at a nice pace, not too fast, not too slow. This should give market participants comfort that the Fed’s monetary policy will not be tightened for a considerable time yet. Meanwhile, the ECB is considering its options in case it needs to act against too low inflation for too long and appears to be warming to QE.

Rates: ECB President Draghi suggested that any QE programme would have a focus on reviving bank lending given the characteristics of the eurozone’s financial system, with purchases of securities backed by loans – especially SME loans – a possibility. However, the market for these securities is too small for a large scale asset purchase programme. We expect inflation to settle at low levels, which should keep the possibility of further monetary easing very much alive. A rate cut rather than QE would be the first step of any further easing.

FX: The euro edged only slightly lower after the ECB signalled that it is more open to further monetary easing to achieve its inflation goal, and talked openly for the first time about the possibility of a QE programme. This is partly because the dollar was undermined by speculation that the Fed may delay rate hikes, while the currency markets might have doubts about the ECB’s conviction. We continue to expect that growing differentials in monetary policy on either side of the Atlantic will lead to a lower euro versus the dollar.