ECB Preview: Change of forward guidance to confirm stimulus is on the way – At the July Governing Council meeting, we expect the ECB to signal that a monetary easing package is becoming an increasingly likely prospect. It will very likely change its forward guidance on interest rates from the current expectation that ‘the key ECB interest rates (will) remain at their present levels at least through…’ to ‘the key ECB interest rates (will) remain at their present levels or lower at least through…’. This would signal that a cut in policy rates is likely at the next Governing Council meeting in September. There is also the possibility that the Council will signal the increasing likelihood of a re-start of QE by adding a line to its forward guidance on its asset purchase programme. For instance, it could say that the ECB would ‘re-start net asset purchases if necessary to ensure sustained convergence of inflation to levels that are below, but close to, 2% over the medium term’. The current guidance refers only to re-investments.
ECB could already act in July – There is a possibility of a cut in policy rates already at this week’s meeting. The macroeconomic conditions for easing set out by the ECB (see below) do seem to have already been met. In addition, Chief Economist Philip Lane outlined that below-target inflation outcomes meant that the ECB needed to prove its commitment to price stability by taking relatively earlier action than if inflation outcomes had been closer to target. In particular, he asserted that in the current situation ‘it is essential that a central bank shows consistency in its monetary policy decisions by proactively responding to shocks that might delay convergence to the target or move inflation dynamics in an adverse direction’. On the other hand, the ECB has tended to take decisions at meetings when it has updated macro projections and the next update is in September. So although it is a close call, we expect the ECB to stand pat in July, but cut all its main policy rates by 10bp in September.
Package of stimulus – As well as a 10bp rate cut in September, we expect an even stronger signal that the ECB is investigating the design of a new asset purchase programme. By December, we expect the ECB to announce the full modalities of a EUR 630bn QE package, to be implemented for 9-months from January 2020 at a pace of EUR 70bn per month. The second 10bp rate reduction will follow in Q1 of next year. However, recent comments from officials suggest that the balance of risks are towards earlier moves.
The case for easing – In his Sintra speech, Mr Draghi signalled a lower bar for monetary stimulus, saying that monetary easing would following if the economy did not improve. This reflects concern about the outlook for inflation. The account of the June Governing Council meeting showed that officials judged that even the ECB’s current medium-term projection for inflation of 1.6% was seen to be some way below the central bank’s goal. That projection is based on a scenario of improving economic growth during the course of this year, so if that fails to materialise, then the medium term inflation projection would move lower still. Most economic data over the last few weeks suggest that downgrades of the ECB’s growth and inflation projections are indeed likely in September. Furthermore, the further decline in market-based indicators of inflation expectations is adding to the concerns of the Governing Council. (Nick Kounis)