ECB Preview: Here Comes TLTRO?

Submitted by RanSquawk

On Thursday at 1:45pm CET/7:45am EST, the ECB's latest monetary policy decision is due. Here is what consensus expects:

  • Unanimous expectations look for the ECB to leave its three key rates unchanged
  • Inflation and growth forecasts set to be lowered
  • Will the Bank provide any further clarity on potential new TLTROs?

PREVIOUS MEETING: The most recent policy announcement saw the Central Bank stand pat on rates as expected and maintain their guidance on rates and reinvestments. Focus for the press conference largely centred around the Bank’s assessment of the growth outlook for the Euro-area with policymakers opting to classify risks as now being ‘tilted to the downside’ vs. their prior view of ‘moving to the downside’. President Draghi stated that the implications for monetary policy from the assessment tweak were not discussed. Elsewhere on the policy front, the matter of TLTROs was raised during the press conference with Draghi stating that subject was brought up by several officials but no decision was taken as the monetary case for a fresh round needs to be presented.

ECB MINUTES: ECB minutes provided little in the way of fresh insight with policymakers concluding that any decision taken on the TLTRO should not be taken too hastily and should serve policy objectives. Furthermore, the account revealed that the Bank  perceives that current market pricing is in-line with their current guidance; something that Draghi alluded to in his January press conference. From a growth perspective, central bankers believed that near-term growth momentum is likely to be weaker than earlier expected, the extent of this conviction will likely be a key source of focus for the March staff economic projections.

SOURCE REPORTS: Since the previous press conference, various source reports have painted a conflicting view about the Bank’s attitude to fresh funding measures with one report suggesting that TLTROs are seen as a priority, whilst another stated that the governing council sees no urgent need to unveil a fresh round of funding and questioned the necessity in doing so at all. On forward guidance, sources suggested that some ECB policy makers are hesitant to change interest rates guidance as it would impact the term of the next ECB President.

ECB RHETORIC: Since the prior meeting, notable communications highlights include comments from ECB’s Coeure who stated that the economic slowdown is stronger and broader than they expected, the inflation path will be shallower, adding that a new TLTRO is possible and the ECB are currently discussing it. Elsewhere, Chief Economist Praet noted he expects near-term projections to be revised lower but what counts is the medium-term and they see positive and negative factors there, adding that a rebound is likely but too early to tell by how much. ECB-hawk Nowotny suggested that the ECB has no conclusions yet on TLTRO, adding that if the slowdown is driven by one-offs, TLTRO may not be needed; decision to be made later than March. Interestingly, Nowotny also stated that he sees a discrepancy between ECB guidance and market expectations. Finally, ECB President Draghi gave little away during his Parliamentary hearing at the end of January by reiterating that significant monetary policy stimulus remains essential.

DATA: From a growth perspective, Q4 2018 Eurozone GDP printed at 0.2% with RBC suggesting that early signals indicate that Q1 2019 will see only a marginal improvement at best. On the inflation front, February Y/Y CPI ticked higher to 1.5% from 1.4% amid a minor uptick in energy prices and unprocessed food, however, the ‘super core’ metric slipped to 1% from 1.1%, highlighting the weakness in underlying price developments. The latest batch of PMI readings saw composite PMI for Feb rise to 51.9 from 51.0 (prelim 51.4) with Pantheon Macro noting a “robust headline, signalling that services continue to show relative resiliency in the face of the sustained slowdown in manufacturing”. On the labour front, Unemployment ticked lower once again in January to 7.8% from the prior 7.9%.

POTENTIAL ADJUSTMENTS TO ECB FORWARD GUIDANCE (INTRODUCTORY STATEMENT)

RATES: With markets currently only pricing in a circa 50% chance of a 10bps deposit rate hike this year, the Bank’s current “at least through the summer of 2019” has continued to be brought into question. Despite source reports suggesting that some at the Bank are reticent to change rate guidance before the current President Draghi is replaced in October, an adjustment at some stage appears to be inevitable, the timing of it though, remains a subject of debate. UBS expect the ECB to acknowledge that rates will likely stay on hold until 2020 at their June meeting, whilst also floating the potential for the Bank to consider a tiered rate system  to alleviate the pressure of negative rates on Eurozone banks. Elsewhere, ING states that changing forward guidance to “interest rates to remain at their current levels at least until the end of the year” is a no-brainer but, this will not necessarily be  implemented at this meeting. This time around, RBC suggest that Draghi is likely to “qualify the ECB’s guidance to indicate a start later than September 2019 by stressing its state contingent aspect – i.e. the ‘at least’ as well as ‘as long as necessary’ parts of  the key sentence”.

ASSET PURCHASES: No changes expected on this front given the recent conclusion of the Bank’s PSPP; a view backed by Rabobank.

GROWTH/TRADE: Given that the last two meetings have seen tweaks on this front, it is unlikely that policymakers will make another adjustment to their assessment of the risk outlook with the latest incoming data neither disappointing enough to justify an even more pessimistic outlook or seeing enough of a pick-up to prompt a reversal in their recent adjustments. Instead, market participants will be looking at the Bank’s growth projections (see below) for greater clarity on the ECB’s current assessment of the risk outlook.

INFLATION: No changes expected on this front. Danske Bank expect the ECB “to hold on to its narrative that ongoing labour market improvements and rising wages will eventually push up underlying inflation pressures.” However, Danske highlight that the minutes from the January meeting note increasing worries at the Bank over the missing transmission from wages to consumer prices.

STAFF ECONOMIC PROJECTIONS:

  • Current ECB HICP forecasts: 2018 at 1.8% (prev. 1.7%), 2019 at 1.6% (Prev. 1.7%), 2020 at 1.7% (Prev 1.7%), 2021 at 1.8%
  • Current ECB real GDP forecasts: 2018 at 1.9% (prev. 2.0%), 2019 at 1.7% (Prev. 1.8%), 2020 at 1.7% (Prev 1.7%), 2021 at 1.5%

Growth: On the growth front, as detailed above, Q4 2018 Eurozone GDP printed at 0.2%, which thus fell short of the ECB’s forecast of 0.4%. RBC note that, although growth is forecast to pick-up in H2, the ECB’s quarterly growth rates of 0.5% look too optimistic given current headwinds. Furthermore, the Bank will likely need to play catch-up to their latest guidance on growth (altered in January), which is yet to be accompanied with a round of economic projections. With this in mind, consensus looks for a downgrade to the Bank’s 2019 and 2020 growth outlook, with 2021 to be subject to little in the way of material changes, if at all.

Inflation: From an inflation perspective, as highlighted earlier in our report, price pressure remains a key concern for the Bank.
Morgan Stanley opines that although the narrative on inflation might not change in the statement, adjustments to staff projections on this front are likely. More specifically, Nomura note that, considering the cut-off point for staff estimates, the oil price  ssumption underpinning the forecasts is likely to be around 8% lower than the one seen in December. This, allied with the weaker growth outlook, Nomura argues could see 2019 and 2020 forecasts lowered. Nomura also highlight the importance of the 2021  forecast, which they explain acts as a useful indicator of the Bank’s stance on policy normalisation, which, if close to 2%, would suggest the ECB believes it remains on track.

Please see below for Danske Bank’s expectations grid for ECB staff projections

TLTRO

TLTROs have been a focus for the market as they are seen as a useful tool for the Bank to help soothe the transition of policy normalisation and shield some of the more fragile Eurozone economies (particularly Italy) this year. At the January meeting, the matter of TLTROs was raised during the press conference with Draghi stating that the matter was brought up by several officials but no decision was taken as the monetary case for a fresh round needs to be presented. Since then, (as discussed above), one source report suggested that TLTROs are seen as a priority, whilst another stated that the governing council sees no urgent need to unveil a fresh round of funding and questioned the necessity in doing so at all. In terms of expectations for this week’s meeting, UBS suggest that given the likelihood of the Bank’s acknowledgement of lower growth and limited inflationary pressures, policymakers will send a strong signal on Thursday that it will soon offer a new TLTRO with a final decision and details potentially to be announced in April. Elsewhere, SocGen look for a formal announcement in June, adding that the decision is far from clear-cut, Barclays look for an unveiling between March and June, whilst Goldman Sachs look for an announcement this week with details to follow at a later point. In terms of how the TLTRO could be offered to lenders, RBC highlight that the main sticking point for the  ECB is more about the design of the operations, rather than whether to offer them or not. RBC explains that one issue facing policymakers is whether or not to offer a fixed rate, which would be at odds with the ECB’s current setting of expected rate hikes, or a floating rate, which could potentially lower the incentives for participation. Furthermore, Rabobank also highlight the potential debate between whether TLTROs will come with the precondition of increased lending or maintaining the current stock of loans; Rabobank favour the latter.

MARKET REACTION

Please see below for ING’s scenario analysis