Global Daily – ECB set to tweak QE guidance

by: Nick Kounis , Kim Liu

ECB View: Minutes signal Governing Council may change its guidance soon – The ECB signalled in the account of the December Governing Council meeting that its forward guidance could change early this year if current macro trends continue. In particular, the account notes that ‘the view was widely shared among members that the Governing Council’s communication would need to evolve gradually, without a change in sequencing, if the economy continued to expand and inflation converged further towards the Governing Council’s aim. The language pertaining to various dimensions of the monetary policy stance and forward guidance could be revisited early in the coming year’. Of course this clearly signals a ‘hawkish’ change in communication about the monetary policy stance, but leaves it open exactly what that might be. However, elsewhere in the account, comments by Chief Economist Peter Praet suggested that it will be the QE guidance rather than the rate guidance that may change, though obviously the two are connected. Mr Praet noted that ‘as progress was made towards a sustained adjustment in the path of inflation, the relative importance of forward guidance on rates in the Governing Council’s policy package would increase’. Finally, the minutes suggest that the ECB Governing Council still feels that inflation converging to the goal still ‘remained contingent on continued support provided by the full range of the ECB’s monetary policy measures currently in place’. Indeed, although the ECB is increasingly bullish on the eurozone economic outlook, it does not yet see sufficient signs that this is translating into a build-up of underlying inflationary pressures. This means that the ECB is unlikely to change its message aggressively.

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Taking all the above into account, what kind of changes in communication could we expect?  It seems most likely that the forward guidance on QE will be gradually tweaked over the next few months to signal that there will not be a further extension of the programme beyond September 2018. That would be consistent with our base case, though we expected changes in language on QE to come in the summer and the minutes suggest these shifts could come earlier (albeit in several steps). We do not expect a change in the guidance that ‘the Governing Council continued to expect the key ECB interest rates to remain at their present levels for an extended period of time, and well past the horizon of the net asset purchases.’ The translation of this guidance depends crucially on whether a tapering period would follow after September 2018 as that would extend the horizon of asset purchases and prolong the moment when interest rates are likely to go up. ECB President Draghi made it clear in October that a tapering period would follow.

The ECB minutes pushed up government bond yields, with Bund yields rising more in the belly of the curve, which saw 5s10s flattening. This reflected that investors priced in more/earlier interest rate hikes. This shift also drove a strengthening of the euro. Indeed, following the release of the ECB minutes, Eonia forward pricing suggests that the market is fully pricing in a 15bps hike in the deposit rate in Q1 2019. This means that under assumption of sequencing and net asset purchases to continue to at least September 2018, (a) that the market expects no taper and a first hike 6 months after the end of the QE programme or (b) a quick taper of say 3 months and a rate hike 3 months after the end of the tapering phase. Both scenarios would mean an aggressive exit. Our view is that there will be a 6-month taper after September 2018 and therefore that the first rate hike will not come until the second half of 2019 (we have pencilled in a move in September). (Nick Kounis & Kim Liu)