ECB View: A policy package excluding large-scale QE will not close the inflation gap – Market doubts about whether QE will be included in the ECB’s stimulus package in September have built over recent days and have helped to fuel the correction in government bond markets. These doubts reflect hawkish comments from mostly hawkish ECB officials and therefore we do not place too much weight on them. That aside, the market consensus of analysts is that any QE programme will be relatively small (around EUR 40bn for 12 months). We think that QE will be included in the package and that it will be big (at EUR 70bn per month for 12 months). Quite simply, a policy package that does not include QE will have no chance of closing the gap between the ECB’s projection for inflation at the end 2021 and the ECB’s inflation aim. The current projection for inflation at the end of the forecast horizon is 1.6%, but it would very likely be revised downwards in the absence of stimulus. At the same time, ECB President Draghi clarified that the ECB is aiming for inflation of 1.9% in the July press conference. Effectively, the ECB might be looking to close an inflation gap of around 0.4-0.5 percentage points.
What kind of policy package would it need to calibrate to do this on the basis of its own forecasts? Helpfully, ECB Chief Economist Philip Lane gave a speech yesterday where he presented forthcoming research from the central bank that provides some insights into this question. In particular, he presented estimates on the impact of different elements of the ECB’s unconventional measures on growth and inflation in 2014-2018 (see here – slide 6). From the charts presented (he did not reveal point estimates) the research estimates that by 2018 the complete package left economic growth around a percentage point higher and inflation around 0.5 percentage points higher compared to the counterfactual. Just under half the impact on growth and around half of the impact on inflation was due to the APP, with the rest split between the other instruments. So without the APP, it would be difficult to design a package, which in the ECB’s eyes, would have the requisite impact on the economic outlook. This point is made stronger by the fact that the impact of the other measures might be more modest this time. For instance, the maturity of the current series of TLTROs is lower than it was in that package. In addition, in 2014-2015, the ECB cut policy rates by 40bp, something it may stretch to do on this occasion.
The effects attributed to the APP (around 0.4 pp on growth and 0.25 pp on inflation) where achieved only with substantial asset purchases. In the first year, purchases under the APP totalled EUR 60bn per month, while they totalled EUR 80bn per month in the second year. Given the ECB may see some diminishing returns to QE and the impact of the other unconventional measures are now likely more modest, the ECB cannot go for a relatively modest purchase programme. (Nick Kounis)
Euro macro: Germany’s industrial sector increasingly hit by eurozone weakness – Orders received by Germany’s industrial companies dropped by 2.7% mom in July, following a rise by the same magnitude in the month before. The monthly drop in orders was broad-based and spread amongst all three main goods categories (intermediate goods, capital goods and consumer goods). The regional breakdown shows that the weakness was concentrated in foreign orders, (-4.2%), but that domestic orders fell somewhat as well (-0.5%). The monthly orders data are very volatile and the three-month growth rate gives a better view of the strengths and weaknesses in the series. Indeed, when looking at 3m-o-3m growth, it turns out that the weakness in orders has shifted from foreign orders towards domestic orders since the first quarter of this year. Moreover, within total foreign orders, the weakness has shifted from orders received from countries outside the eurozone towards orders received from within the eurozone. In other words, the orders data signal that, compared to the first few months of this year, Germany’s industrial sector is hurt increasingly hard by domestic weakness and weakness in other eurozone countries rather than by weakness outside the eurozone. (Aline Schuiling)