The European Central Bank is done with major policy surprises for the foreseeable future.
We believe that from here, ECB President Mario Draghi will work on managing expectations at future Governing Council (GC) meetings by emphasizing the quantitative easing (QE) message: technical issues, progress with implementation and impact on financial markets and the real economy.
There is no substance to recent market talk of ECB tapering in light of improved macro data. After more than one year preparing for QE, Draghi is not going to begin the exit discussion just one month into implementation. The staff’s upwardly revised macro forecasts for 2016 and 2017 (growth at 1.9% and 2.1% and inflation at 1.5% and 1.8%, respectively) incorporate implementation of the €1.14 trillion QE program announced in January.
The fact that the March minutes mention seven times, directly and indirectly, that the forecasts are “predicated on the full implementation of all monetary policy measures taken by the Governing Council, including the expanded APP [asset purchase program] comprising monthly purchases of €60 billion …”, strongly signals Draghi is intent on seeing the QE plan implemented in full.
And with five-year maturity inflation swaps beginning in 2020 only at 1.7%, indicating that long-term inflation expectations are anchored slightly below the ECB’s inflation target, the exit discussion is premature despite recent macro green shoots.
The GC expanded the list of agency issuers eligible for QE purchases at today’s meeting and will likely tweak further modalities of QE in coming months, but these changes do not move the strategy needle. Further changes can be expected in two areas: adding Cypriot government bonds to QE purchases and reviewing the issue and issuer limits the ECB and national central banks impose on the bonds they are buying.
We would rule out a further rate cut at this stage. The transition to QE signaled a shift from rates to the balance sheet as the primary tool for easing policy, and indications from the GC point to little appetite to take the Deposit Facility interest rate lower than −0.2%. Further rate cuts hypothetically would come into play, alongside QE2, if another negative demand shock necessitated additional easing.