EUR/USD: Nothing New From Draghi - QE Extension Expected In December

The ECB left all its interest rates unchanged, in line with our and consensus expectations. The introductory statement was very similar to last month’s and the press conference did not provide new policy hints. However, Draghi’s remarks do support our view that in December QE will be extended beyond March 2017 at the current pace.

In a relatively uneventful press conference, the most important message came when Draghi reaffirmed the Governing Council’s commitment to preserve the “very substantial” policy support that is embedded in the ECB’s staff projections and that is needed to push inflation back towards target. Considering 1. that this support reflects market expectations that stimulus will continue and 2. underlying inflation remains lifeless while inflation expectations still hover around record-low levels, we really do not see any other viable options for the Governing Council aside from extending QE beyond March 2017 at its current pace of EUR 80bn per month.

That said, Draghi gave the impression that the Governing Council’s discussion is still at a very preliminary stage, with no clear view shaping up yet. Today he told us that QE extension and tapering were not discussed and that a sudden stop to the purchase program is highly unlikely. The market initially read as a hawkish message Draghi’s acknowledgment that stimulus cannot remain in place “forever”. But the market reaction has reversed soon.

So any policy decision will be announced on December 8, when the new macroeconomic projections will be published (they will include for the first time numbers for 2019). What will the ECB do at that meeting? We remain convinced that the GC will opt for an extension of QE by six to nine months at the current pace. This would require EUR 480-720bn of additional purchasable assets. We estimate that, under current market conditions, raising the ISIN limit from 33% to 50% and applying the deposit-rate restriction to a portfolio of bonds rather than to individual bonds would free a sufficient amount of German paper to make this extension possible. Bank bond purchases do not seem to be on the agenda, while a deposit rate cut remains highly unlikely as its side effects would outweigh the benefits.

Although there was no surprise in Draghi’s announcement, the EUR/USD broke below the June low at 1.0912. The bias remains on downside. A series of long black candlestick in October weighs heavily on the outlook. We expect the bear cycle to be continued down to 1.0826 –March low. However, it would be too risky to open a short position at these levels.