Today's ECB meeting is expected to be one of the most important in recent years: Mario Draghi has signaled, and is widely expected to announce a blueprint of what the central bank's QE tapering will look like beyond 2017, and while no actual tightening will be implemented - either via rates of asset purchases - the ECB is expected to announce it will cut its €60bn/month bond purchases in roughly half starting in January 2018 and lasting for the next 9-15 months.
Courtesy of RanSquawk, here are the key parameters of Thursday's meeting:
- Rate Decision due at 1245BST/0645CDT and Press Conference at 1330BST/0730CDT
- The ECB is widely expected to keep all rates on hold, with rate hikes not expected until after conclusion of current QE programme
- The ECB is expected to unveil a road-map for reducing the pace of asset purchases given rhetoric from Draghi at the previous press conference
- Consensus far from clear on how much the ECB will reduce purchases by and how long they will be extended for
RATE/ASSET PURCHASE EXPECTATIONS
- DEPOSIT RATE: Forecast to remain unchanged at -0.40%. The rate was last adjusted in March 2016, when it was cut by 10bps.
- REFI RATE: Forecast to remain unchanged at 0.00%. The rate was last adjusted in March 2016, when it was cut by 5bps.
- MARGINAL RATE: Forecast to remain unchanged at 0.25%. The rate was last adjusted in March 2016, when it was cut by 5bps.
- ASSET PURCHASES: Views on this front are particularly wide-ranging. A Reuters poll suggests that the ECB will start trimming monthly asset purchases to EUR 40bln from current EUR 60bln in January. Views are mainly split on whether this will be via a 6- or 9-month extension. However, Bloomberg News reports that the Bank will half purchases to EUR 30bln (a view backed by recent source reports) while extending the programme by 9-months in order to take the total size of purchases to around EUR 2.5trl; a level seen by some as their maximum purchase limit. (Discussed in greater detail later on in the report)
CURRENT ECB FORWARD GUIDANCE
- RATES: “We expect [rates] to remain at their present levels for an extended period of time, and well past the horizon of our net asset purchases.” (ECB statement, 7/Sept)
- ASSET PURCHASES: “Net asset purchases, at the current monthly pace of EUR 60bln, are intended to run until the end of December 2017, or beyond, if necessary” (ECB statement, 7/Sept)
- GROWTH: “The risks to the growth outlook are broadly balanced.” (ECB statement, 7/Sept)
- INFLATION: “While the ongoing economic expansion provides confidence that inflation will gradually head to levels in line with our inflation aim, it has yet to translate sufficiently into stronger inflation dynamics. Measures of underlying inflation have ticked up slightly in recent months but, overall, remain at subdued levels. Therefore, a very substantial degree of monetary accommodation is still needed for underlying inflation pressures to gradually build up and support headline inflation developments in the medium term.” (ECB statement, 7/Sept)
POTENTIAL ADJUSTMENTS TO ECB FORWARD GUIDANCE
- RATES: Expected to stick to current rhetoric with any adjustments on rates not expected until QE unwind as part of their ‘sequencing’ efforts.
- ASSET PURCHASES: This will hinge on what action the ECB will take. (Expectations for this are discussed below).
- GROWTH: No change to guidance expected on this front. RBC states there has been little in the way of economic data flows to materially alter the economic backdrop.
- INFLATION: Similarly to the growth story, little has changed on the inflation front to require any adjustment to current guidance.
FUTURE PATH OF QE PROGRAMME
Despite inflation in the Euro-area (1.5% Y/Y headline) still short of the ECB’s ‘close to but below 2%’ target, the Bank has found itself under pressure to set out a road-map on how they will curtail purchases. This is a by-product of a pick-up in Euro-area sentiment and growth expectations but more pertinently, the concerns on the governing council surrounding the Bank moving ever closer to their alleged self-imposed purchase limit of around EUR 2.5trl (set to reach EUR 2.28trl by yearend)
Expectations for such a blueprint were stoked by comments from ECB Draghi at his most recent press conference stating that very preliminary talks had begun on asset purchases with discussions based on the length of the programme and size of the purchases. Draghi then went on to add that the ‘bulk of decisions will be taken in October’.
Since then, rhetoric from the Bank has done little to pull-back expectations of a major announcement this month. However, many members appear to be trying to soothe markets by not being too bullish in the desires to remove accommodation with the likes of Draghi, Praet and Hansson all opting to use the phrase ‘recaliberation’ instead of ‘taper’ when talking about unwinding purchases. Furthermore, even some of the more hawkish members such as Weidmann have tried to reassure markets by stating that policy will remain accommodative even after QE exit, with his German counterpart Lautenschlaeger suggesting that current downward forces on in inflation are merely temporary. As such, this suggests that any action taken by the bank will likely be mindful of any market backlash by being too aggressive with members stressing the need for patience and persistence. However, there has been little communication by policymakers on the specifics of what to look out for and as such, unless there are any further developments heading into the meeting after this report has been published, consensus will likely be far from clear.
Overview: Expectations for the Bank’s future plans focus on two key aspects of the programme; it’s size and it’s duration with purchases currently running at EUR 60bln a month and due to expire in December of this year. For the reasons stated above, the current size is expected to be reduced from its current level with the programme to be extended in order to avoid any type of ‘taper-tantrum’.
Source reports: In the immediate aftermath of the previous press conference, source comments suggested the Bank could cut asset purchases to EUR 20 or 40bln a month, with extension options including 6- or 9- months. Given the wide range of potential future purchases from these source reports (EUR 120-360bln), markets have been struggling to get a gauge on where the balance of views at the Bank lies. As such, source reports have been one of the main tools used by the market to gain consensus. The most recent of these reports suggested that the Bank could cut purchases to EUR 30bln with a 9-month extension due to fears regarding limits on available purchases. The same sources also reported that EUR 25bln for 9 months could be a more secure approach to avoid falling short of available bonds. That said, the report highlighted that no key decision have yet been made and as such, the decision taken by the bank could be one that goes right to wire. Given the lack of market consensus, it is plausible that the ECB could release further source reports in order to communicate their potential decision ahead of the event.
Newswire polling: Given the lack of clarity in market expectations it is useful to look at newswire surveys given they typically highlight where the balance of views lie in the market. However, even on this front, major vendors report differing views on what action the ECB could take. A Reuters poll suggests the ECB will start trimming monthly asset purchases to EUR 40bln from current EUR 60bln in January. Expectations were, however, relatively wide-ranging with expectations of cuts between EUR 5-40bln. Fourteen of 32 surveyed (who expect a fixed end-date) think the programme will run for a further 6-months from January, thirteen of 42 look for an extension to September (a view backed by recent source reports) and the remainder expect it to run until December 2018. Note, some also hold the view that the ECB could leave the programme open-ended in order to not cause too much of a stir in the market via a ‘taper-tantrum’. Separately, Bloomberg News reported that the consensus is for asset purchases to be cut to around EUR 30bln and extended by 9-months which would take the bank’s total size of purchases to just over EUR 2.5trl; the bank’s alleged self-imposed bond-buying limit.
The market reaction to this week’s meeting could carry a lot of volatility given the lack of clear consensus. As such, to help clients we have referenced Rabobank’s, BofA's and Citi's cheat sheets to depict what could be interpreted as ‘hawkish’ or ‘dovish’ reactions. Note, a hawkish reaction would typically lead to (all things equal and in very basic terms), appreciation of the EUR, downside in equities and fixed income markets. A dovish reaction would be the converse of these moves. Note that the below categorizations are based on views provided by Rabobank and not out own. Furthermore, the values stated below refer to what the pace of future purchases would be, not the size of the cut.
- Very hawkish: EUR 20bln and a 6-month extension
- Hawkish: EUR 20bln and a 9-month extension or EUR 30bln and a 6-month extension
- Neutral: EUR 20bln and a 12-month extension or EUR 30bln and a 9-month extension
- Dovish: EUR 40bln and a 6-month extension or EUR 30bln and a 12-month extension
- Very Dovish: EUR 40bln and a 9-month extension or EUR 40bln and a 12-month extension
Alternatively, here is Bank of America's Matrix...
... and Citigroups.
Below are Citi's conclusions:
- For 10yr Bunds, yields fall around 25bp in the most dovish scenario (€40bn x 12mth) and rise around 24bp in the most hawkish scenario (€20bn x 6mth). Figure 1 above summarizes the full set of results for Bunds.
- The most market neutral scenarios, according to the model, are €20bn x 12mth, €30bn x 9mth and €40bn x 6mth.
- This is broadly consistent with the Reuters poll (taken 11-14 September) which suggested the consensus amongst economists was for €40bn (range €30- 50bn) over 6mths (range 3-12mths).
- Cross-checking the model output (based on policy signals) with the total size of APP extension shows a clear relationship (Figure 2). The model therefore assumes that there is less of a role for the ‘intensity’ of purchases.
- The market neutral size for APP upsizing appears to be around +€250bn
- The Citi house view is for an extension in the form of an ‘envelope’ (without specifying a monthly purchase rate) of €150bn (with upside risk of €210bn). That could lead to a near-term sell-off of around 15-20bp.
- The scenarios presented assume deliverability. But, the most dovish options undoubtedly would be more challenging to implement (see below) given scarcity constraints. In terms of likelihood, we would put less weight on these scenarios which skews the risk towards a bearish reaction on 26 October.
Finally, a breakdown of expectations by bank:
- Barclays - Think that QE will be extended for a longer period (nine months) but at a lower pace of EUR 30bln per month, and do not rule out a 12-month extension at an even lower pace of EUR 20-25bln. Do not expect the ECB to commit to tapering towards zero at the end of the extended programme as the GC will likely want to keep all options open in case economic or market conditions deteriorate in the meantime.
- Deutsche Bank - Now expect a larger reduction in the pace of QE – from EUR 60bln to EUR 30bln (not EUR 40bln). To compensate, expect (i) a longer extension of QE – nine months rather than six months – (ii) a commitment to not changing the sequencing of exit and (iii) the introduction of conditionality into the definition of “well past” within the rates guidance.
- HSBC - Expect six months of asset purchases at a reduced pace of EUR 40bln per month to start in January. Although, it is hard to have huge conviction given the near infinite possibilities. Do not think the ECB will set an end-date for purchases given concerns that underlying inflation pressures are still insufficient.
- IFR - Central scenario is for the ECB to buy EUR 20bln per month over 12-months. The most important element to the ECB’s exit strategy is not QE but sequencing of when rate hikes will happen.
- ING - Expect the ECB to announce a ‘lower for longer’ tapering, as in December 2016, reducing the monthly QE purchases to 25bn and extending them until the end of 2018. Expect Draghi to emphasise ‘sequencing’, i.e. the fact that interest rates will remain low (far) beyond the end of QE which should help to anchor interest rate expectations. Such a strategy would also help to immunise the ECB’s monetary policy against further exchange rate fluctuations.
- Lloyds - Forecast an announcement of a reduction in monthly purchases to EUR 30bln from the current pace of EUR 60bln, but an extension of the programme to at least September 2018. The ECB is likely to maintain its flexibility, keeping open the option to increase monthly purchases, should it be needed.
- Morgan Stanley - Have slightly amended their call and now expect the central bank to announce that the APP will be extended up to September 2018, or beyond if necessary. But, from January onwards, the pace of purchases will likely be lowered to EUR 30bln per month.
- Nordea – Expect an extension of the asset purchases by at least six months, by reducing the monthly net purchase volume from EUR 60bln per month to EUR 30bln, effective from January 2018. This would be in line with the need for further substantial monetary accommodation, while at the same time reflecting bond scarcities and the ECB’s confidence that ongoing growth above potential should drive core inflation further up over time.
- Pictet – Expect the ECB to announce a 9-month extension of asset purchases, until at least September 2018, at a monthly pace of EUR 30bln. The ECB’s emphasis on “patience and persistence” means that an even longer QE extension is possible, e.g. at EUR 20-25bln for 12 months.
- Rabobank – Believe that QE will be wound down in three steps of EUR 20bln, bringing purchases to zero in H2 2018. Rabo admit that their scenario is on the more hawkish side of the tapering spectrum. If the ECB opts for such an exit, this could lead to a negative market reaction in the short-run. However, they would argue that ultimately the flexibility given by this approach could actually help stabilising yields in the long run (and so limit sharp movements).
- RBC - Look for a reduction by at least EUR 30bln in net terms, possibly even more. The duration of the programme is likely to remain open ended with an initial date set at least 9 months from the current end date, i.e. in Sep 2018. Forward guidance should be strengthened and re-iterated in the press conference and Q&A – particularly the sequencing element.
- SocGen - Expect the ECB to extend QE for nine months, at a monthly pace of EUR 25bln. Expect the ECB to keep the door open to more QE thereafter if needed. Maintain their view of rate hikes in March and June 2019 to put an end to the negative deposit rate.
- TD Securities - look for the ECB to announce QE at EUR 30bln/month for 12 months. Recent ECB communication has suggested that emphasis will be on the duration of QE rather than the pace. This longer extension of QE should be coupled with unchanged forward guidance, where Draghi will emphasise that purchases will continue through December 2018 “or beyond, if necessary” and will remain firm on sequencing, with rates not rising until “well past” the end of QE. This should see any expectations for rate hikes pushed back into the second half of 2019.
- UBS - Expect the ECB will cut its monthly asset purchases from EUR 60bln to EUR 30bln as of January, with a commitment for nine months, i.e., until end-September 2018. UBS think the ECB will leave open whether it will extend QE after September and hint that this decision will be taken in a data- dependent fashion, closer to the time.