No ECB easing despite fear of stagnation

Mario Draghi’s biggest fear for the euro area is protracted stagnation. Nevertheless, the ECB did not ease today.

An interesting part of today’s ECB meeting was that the Governing Council discussed a quantitative easing (QE) programme. Last month, Draghi slightly opened the door for this, as he mentioned QE while listing a number of easing measures. Today, he was much more direct and said the Council is ‘unanimous on unconventional tools’.

The ECB also discussed negative deposit rates as well as a narrowing of the rate corridor and related to this Draghi said that ‘the ECB has not yet finished with conventional measures’.

Hence, it seemed that Draghi tried to use his old strategy of verbal intervention but it had only a marginal market influence. Could it be that markets are starting to get tired of soft words and now want action?

At the latest meeting, Draghi focused on the recovery and how things had started to look better but today focus was back on inflation. The message from Draghi seems to be that another negative surprise on inflation would lead to more easing, as this is very likely to change the ECB’s outlook for inflation. So far, it is too early for the ECB to conclude whether the outlook has changed and it maintained its wait-and-see approach.

In our view, the ECB is too optimistic on inflation and we will get more negative surprises. Based on Draghi’s communication today, we expect this to lead to further easing.

In our view the timing is still very unsure. We think the ECB’s inflation forecast is too optimistic for Q2 but in coming months base effects are likely to lead to higher inflation, which would buy the ECB some time. Hence, it could be that the ECB will remain on hold until H2. Moreover, the tool is also very uncertain. Although the Governing Council is now considering a QE programme, it looks as though it has not found a preferred tool to use in fighting low inflation.

As expectations going into today’s meeting were lighter than previous meetings in 2014, the disappointment of unchanged policy has not had a great influence on the fixed income market. German 10Y moved marginally during the ECB meeting and most selling pressure was observed at the front of the Euribor and Eonia curve, as we now have confirmation of unchanged liquidity dynamics in the next maintenance period, including the usual volatile period of Easter. However, as QE was a more explicit subject at today’s meeting, peripheral spreads are tighter on the day.