March 8th, 2018

ECB Fixed Income Note Morning Note

March 2018 ECB meeting preview: all about the fine print

  • With no policy change yet in sight for a while, the ECB meeting will be all about fine print in the Governing Council statement. Guidance lingo if you will. Press reports last week suggest that the link between QE purchases and progress on inflation won’t be cut today, but has been delayed to the April or June meeting. However, I – rather foolhardily – believe that the changes will still be made today.
  • Here’s what the fuss is all about with regards to changes in the Governing Council statement:

 

“Regarding non-standard monetary policy measures, we confirm that our net asset purchases, at the new monthly pace of €30 billion, are intended to run until the end of September 2018, or beyond, if necessary, and in any case until the Governing Council sees a sustained adjustment in the path of inflation consistent with its inflation aim. If the outlook becomes less favourable, or if financial conditions become inconsistent with further progress towards a sustained adjustment in the path of inflation, we stand ready to increase the asset purchase programme (APP) in terms of size and/or duration. The Eurosystem will reinvest the principal payments from maturing securities purchased under the APP for an extended period of time after the end of its net asset purchases, and in any case for as long as necessary. This will contribute both to favourable liquidity conditions and to an appropriate monetary policy stance.”

Given the self-imposed constraints on the QE program and prior cuts in monthly purchase volumes, nobody in their right mind believes QE will be extended in any way, unless it’s a short taper to zero monthly purchases in the fourth quarter. Hence, I expect the statement to reflect that QE is no longer to be increased in a meaningful. So, Draghi & Co could simply state that QE will run until the end of September, while no longer suggesting the size of the program (either the total stock of bond holdings or monthly purchase volumes) will increase in a meaningful way.

  • To cushion the blow of QE winding down, the ECB will likely emphasize that interest rates will stay where they are for quite some time, and that the stock of QE holdings will help keep financial conditions easy. Regarding the former, the ECB will likely strengthen the guidance that interest rates will stay low for an extended period of time. Here’s the language from the January statement:

 

We continue to expect them [interest rates] to remain at their present levels for an extended period of time, and well past the horizon of our net asset purchases.”

Instead of expect, the ECB could say ‘intend’. And it could offer more clarity on what “well past” and “an extended period of time” actually mean. At pixel time markets had priced in a deposit rate hike in March 2019, which is way too soon. Interest rate hikes are a late 2019 thing.

  • But beware that it might all come too soon for the ECB, and that tightening is dragged out further. If that’s the case, there will still be guidance chances today, though they will be more modest. Consider the following language:

 

“Overall, an ample degree of monetary stimulus remains necessary for underlying inflation pressures to continue to build up and support headline inflation developments over the medium term. This continued monetary support is provided by the net asset purchases, by the sizeable stock of acquired assets and the forthcoming reinvestments, and by our forward guidance on interest rates.”

Notice that the Governing Council mentions asset purchases first. Instead, Draghi & Co could highlight the importance of the size of its bond holdings and reinvestments, and the promise to keep rates low for now.

  • Other changes to expect in the statement are a cosmetic upgrade of the economic assessment, but no changes in the inflation assessment (yet to show convincing signs of a sustained upward trend will be repeated), nor the balance of risks (should stay balanced). I’m agnostic about the reference to upward pressure on the euro. However, I wouldn’t be surprised if the ECB repeats the exchange rate volatility warning, given the bellicose language on trade across the Atlantic.
  • In any case, the bottom line is that the ECB is crawling towards the exit as lack of core inflation and wage growth prevent it from tapping the brakes a bit more. Expect QE to run until the end of the year, and rate hikes to be a late second half of 2019 thing. At the same time we’re still clueless on how the ECB is going to raise rates in an environment of excess reserves sloshing around. It’s here that we want to see guidance, not if QE is going to last another nine or just six months.
  • Also out are new ECB staff forecasts. At this point I expect only changes in the margin: the GDP forecast for 2018 should be raised by 0.1bps or maybe even 0.2bps from 2.3%, while the unemployment forecasts could be lowered by a similar amount from the current 8.4%. I’m agnostic about the 2019 and 2020 growth and unemployment forecasts, except that they should continue to suggest above potential GDP growth (potential growth is roughly 1.5%), while unemployment should fall below the estimates of the natural unemployment rate of 7.6% to 8.0%. What’s important are the forecast for wage growth and core inflation in particular. With a disappointing outcome of German wage talks and no wage growth in the big member states outside of Germany, wage growth of 2.1% in 2018 looks like a tall order. Core inflation forecasts of 1.5% in 2019 and 1.8% 2020 look high too – in a goal-seeking way. We’ve yet to see signs of anything resembling of an uptrend in core inflation, despite three years of so-called extraordinary monetary easing. Of course, with the ECB reaching the issue/issuer limits of the QE program (there simply aren’t enough bonds for the ECB to buy) Draghi & Co need fig leaf cover to tighten policy. Enter the staff forecasts.