Global Daily – Will the ECB move in October or December?

by: Nick Kounis

ECB View: We stick to a call for a December announcement – The debate on additional ECB stimulus has shifted from being about an issue of ‘if’ to one of ‘when’. This reflects signs that the eurozone economy is losing momentum, weak underlying inflationary pressures, the second virus wave and new restrictions and a change of tone by central bank officials. So could the ECB surprise with an earlier than expected move in October?

The case for an early move is as follows. If it is already clear that the central bank needs to move, then it should not delay. Pre-emptive action can also be more powerful than falling ‘behind the curve’ in terms of shaping expectations in financial markets. In addition, there is a risk management argument, given that the outlook could deteriorate sharply in coming weeks if virus trends do not improve and governments react by intensifying restrictions considerably further.

Despite the strong arguments in favour of early action, we still think that the ECB will hold off and wait until December. There appear to be differing views in the Governing Council on whether to continue with a wait and see approach. Executive Board member Fabio Panetta, the Governor of the central bank of Spain Pablo Hernández de Cos, the Governor of the central bank of Finland Olli Rehn and to a lesser extent Chief Economist Philip Lane have made the case for further stimulus. On the other hand, ECB Vice President Luis de Guindos, Bundesbank President Jens Weidmann, DNB President Klaas Knot and the Governor of the Banque de France François Villeroy have made the case for waiting. ECB President Lagarde appears to want to build a strong consensus before taking action.

Second, many officials may judge that there is still plenty of room within the PEPP to step up purchases in the coming weeks as downside risks intensify (though it is surprising they have not done this already).

Third, although the ECB may already judge that further stimulus is necessary, it may need more information to decide on the shape and size of that stimulus. The Governing Council will have the new macro staff projections in December, while it will also be clearer how the second wave of the virus and government restrictions are evolving. Finally, the ECB could already signal at this month’s meeting, that it is very likely that stimulus will be announced in December.

What will further ECB stimulus look like? We think that asset purchases under the PEPP will still very much be the central plank of the package. The ECB judges that QE has had the biggest impact on growth and inflation relative to its other policy tools. In addition, the PEPP has much more flexibility than the APP.

Meanwhile, the ECB could decide on further measures to support banks. The TLTRO conditions could be further eased, while the TLTRO rate could be cut further. In addition, the ECB may well decide to increase the multiplier for the calculation of the allowance of excess reserves that banks can hold free of charge. An increase in the tiering system ratio could modestly reduce the burden of direct costs to banks from negative interest rates. With excess liquidity surging and interbank rates having fallen sharply, the case for this move is strong.

Finally, we do not expect a reduction in the deposit rate. Although the ECB has kept the option of a cut in the deposit rate open, the Governing Council has refrained from using it. ECB Executive Board member Isabel Schnabel explained in April that ‘a further cut in our main policy rate – the deposit facility rate – would have been unlikely to support sentiment and market functioning at a time when banks’ profitability was already expected to come under additional pressure due to the crisis’. It seems that a deposit rate cut would only be considered seriously as an option in the case of an ongoing sharp appreciation of the euro. However, the euro’s upward trend has fizzled out over recent weeks. (Nick Kounis)