ECB: No sovereign QE for Christmas, but promises of a New Year's resolution
Markets appear disappointed by the lack of news from the ECB on QE. However, the tone remained dovish and open to additional stimulus.
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European Central Bank (ECB) president Mario Draghi confirmed that the Governing Council decided not to change either interest rates, or the ECB's asset purchase programme following the meeting. Given the negative reaction in financial markets, it appears that investors were positioned for the introduction of sovereign quantitative easing (SQE). Draghi said that the outlook for growth and inflation has worsened over the past quarter, but that the committee remained confident that the measures announced so far (ABS and covered bond purchases) will be effective.
We expect the European Central Bank to begin sovereign quantitative easing in the new year.
Draghi repeated that "…the Governing Council remains unanimous in its commitment to using additional unconventional instruments within its mandate. This would imply altering early next year the size, pace and composition of our measures." He also said that in response to the request made last month "…ECB staff and the relevant Eurosystem committees have stepped up the technical preparations for further measures, which could, if needed, be implemented in a timely manner." Draghi has essentially promised to re-examine the effectiveness of the measures introduced so far in January and March in order to decide whether more needs to be done. Indeed, based on the latest projections from ECB staff, the Governing Council may be very close to pulling the SQE trigger.
The ECB staff projections now show growth in 2015 to be just 1%, compared to 1.6% in the previous forecast (September). Growth for 2016 has also been downgraded from 1.9% to 1.5%. The forecast for annual HICP inflation was downgraded from 1.1% to 0.7% for 2015, and from 1.4% to 1.3% for 2016. Compared to the Schroders forecast, the ECB is more optimistic on growth for both 2015 and 2016. The ECB forecast for inflation in 2015 is lower than our own, but is higher in 2016.
The fall in oil prices has been the main change to the outlook over the past quarter. Lower energy prices will boost the purchasing power of households, mimicking the impact of a tax cut. However, lower energy prices will also lower overall inflation over the coming months, which concerns the ECB as there is a risk that the temporary fall in the annual comparison becomes ingrained in households’ inflation expectations.
Despite the still dovish tone from Draghi, markets reacted negatively to the news. The EuroSTOXX 50 index fell just under 1.8% compared to just before the press conference, while government bond yields rose (prices fell), and the euro rose about 0.9% against the US dollar. Markets may have also reacted negatively to Draghi’s admission that not all Governing Council members backed the introductory sentence referring to the intention to move the ECB’s balance sheet “…towards the dimensions it had at the beginning of 2012.” The size of the balance sheet has been a key focus lately and is seen as the ECB’s main policy tool moving forward.
In our view, there were no real surprises today. The language remained dovish and open to additional stimulus, but also reflected some of the Germanic dissent in the committee. We expect the ECB to begin SQE in the new year for three reasons. First, the euro on a trade weighted basis has actually appreciated since October, largely due to other non-US currencies depreciating more aggressively than the euro. The second reason is the lack of bank lending to households and corporates. While this should improve, we doubt it will do so quickly enough to satisfy the ECB. Finally, growth and inflation are unlikely to improve in the near term. Indeed, Draghi has already stated that the ECB’s forecast was closed before the full fall in oil prices was realised, suggesting additional downside risks to the inflation forecast. SQE will probably follow, but remember, this is a central bank that will represent 19 member states from January, and so behaves like an oil tanker – incredibly slow to change direction. After all, it has taken 13 years for the ECB to move into its new offices! So markets will have to make do without QE for Christmas, but a New Year’s resolution may bring cheer in 2015.