Global Daily – QE bias dropped, but normalisation will still be slow

by: Nick Kounis , Aline Schuiling , Kim Liu

The headline grabber following today’s ECB meeting was the Governing Council’s unanimous decision to remove the QE easing bias from its forward guidance. The dropping of the QE bias is a surprise to us, but we do not judge that it has major implications for the speed of the ECB’s exit compared to our current base line scenario.

QE on its last legs – The ECB’s forward guidance no longer asserted that ‘If the outlook becomes less favourable, or if financial conditions become inconsistent with further progress towards a sustained adjustment in the path of inflation, the Governing Council stands ready to increase the asset purchase programme (APP) in terms of size and/or duration’. ECB President Draghi explained that the circumstances in which this contingency would need to be triggered were becoming increasingly unlikely. Given that the ECB has dropped the possibility of a ‘duration’ increase, it is an implicit signal that a further QE extension after September is unlikely. However, a tapering period still seems probable in our view (see below).

Interest rate guidance still in place  – The ECB stuck to its forward guidance on interest rates, that ‘the Governing Council expects 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’. In the Q&A, Mr Draghi signalled that the stock of QE was of key importance, but that the flow of net purchases was still relevant in terms of guiding market expectations for the timing of the first interest rate hike. This suggests that the ECB could use the length of the tapering period beyond September to push out market rate hike expectations. To this end, it could also become explicit about what ‘well past’ concretely means. We think the ECB could reference a specific date. For instance, the expectation that interest rates would remain on hold ‘during at least the first half of 2019’.

Still not convinced about inflation – Although the economic recovery is making the ECB more confident about reaching its inflation goal over the medium term, it is still not convinced, with the ECB President declaring that the central bank could not yet declare ‘victory’. The Governing Council noted that ‘measures of underlying inflation remain subdued and have yet to show convincing signs of a sustained upward trend’, while Mr Draghi said it was ‘still necessary’ to see these trends. Indeed, he asserted that policy would continue to be ‘reactive’, suggesting that trends in underlying inflation would determine the pace of the exit. Our view is that underlying inflation pressures will build only gradually and hence policy normalisation will be slow.

ECB projections virtually unchanged – The ECB’s new macroeconomic projections for the euro area include only a slight upward revision for GDP growth in 2018 (up to 2.4% from 2.3), while the forecasts for 2019 and 2020 were kept unchanged (at 1.9% and 1.7%, respectively). The ECB’s forecast for headline inflation in 2018 was kept unchanged (1.4%), while the forecast for 2019 was revised slightly lower (to 1.4% from 1.5%) and that for 2020 was kept unchanged as well (1.7%). The ECB also kept its forecast for core inflation during the entire forecasting horizon unchanged, at 1.1% in 2018, 1.5% in 2019 and 1.8% in 2020.

Our base scenario for the ECB – We continue to think that the ECB will set out a clear roadmap for the end of its asset purchase programme in June. We expect a tapering period of 6 months (3 months EUR 20bn p/m and 3 months EUR 10bn p/m). We do not expect the first rate hike to follow until the second half of next year (10bp in September and another 10bp in December). We expect the ECB to maintain or even strengthen its forward guidance on interest rates in June. (Nick Kounis, Aline Schuiling & Kim Liu)