ECB: Dovish Taper or Hawkish Ease?

The ECB announced it would extend its asset purchases from April through December next year, but at a modestly slower pace of 60 bln euros rather than 80 bln euros.

We had been expected a six-month extension but without tapering. This would have added 480 bln euros and instead what the ECB will buy is 540 bln euros. The ECB will also expand the range of maturities it buys, and will allow the purchases of instruments yielding less than the minus 40 bp deposit rate.

The end date remains soft in the sense that asset purchases will continue until the Governing Council sees substantial adjustment in inflation toward the central bank's target. The staff forecasts warn of risks of a further extension of the bond buying. In its new forecasts that go out until 2019, the staff does not see inflation above 1.7%. In fact. forecasts 2017 inflation at 1.3% from September's 1.2%. Inflation in 2018 is now expected to be 1.5% instead of 1.6%. Draghi was clear on this point: The 2019 staff forecast "isn't really meeting the goal."

The staff made a minor adjustment to its GDP forecasts. It took next year's estimate to 1.7% from 1.6% and kept 2018 at 1.6% and introduced its 2019 GDP forecast at 1.6%. That is probably very close to what can be regarded as trend growth. In comparison, US trend growth is estimated by the Fed at 1.8%. The BOJ estimates trend Japanese growth nearer 0.2%.

There are downside risks associated with the forecasts, but Draghi acknowledges that deflation pressures are "largely disappeared". This seems to be largely because of the rise in energy prices. Core inflation has been remarkably steady in the trough.

Draghi was clear in the press conference. There was a "very broad" consensus to extend the purchases, and, importantly, that tapering was not discussed. The spin Draghi wants the market to take away is the that the ECB will have a sustained presence on the markets.

The euro initially spiked to $1.0875 as stops were triggered and the knee-jerk market focused on the 60 bln euros of purchases rather than 80 bln. However, the euro was sold off quickly and fell to $1.0640 during the press conference before stabilizing. A bounce toward $1.0730 may be sold. European long-end bonds yields jumped higher and appears to be the main force lifting US yields. However, at the shorter-end of the curve, European yields including Italy are lower. The US premium over Germany, which we think is helpful in understanding euro movement, is up nearly 8 bp on the day. At 184 bp it is at a new five day high. The multi-year peak was seen last week near 188 bp (on a closing basis).