The ECB will continue its QE purchases beyond September 2016

The ECB president Mario Draghi was very dovish at today’s ECB meeting and we now expect the ECB to extend the QE purchases beyond September 2016. Our changed expectation mainly followed, as the ECB projects headline inflation to be only around 0.9% in Q2 2016 and 1.2% in Q3 2016 when the ECB is set to end the QE purchases. In our view the ECB will continue its purchases if inflation is around those levels as the ECB also only forecasts inflation to increase to 1.5% in Q4 2016 (see chart 1).

While the ECB lowered its headline inflation projection for 2016 by 0.4pp to 1.1% it kept its core inflation forecast for 2016 unchanged at 1.4%. We continue to believe the ECB is too optimistic on its outlook for core inflation as slack in the labour market will still be a headwind to higher wage growth in 2016. Hence, we do not see it as very likely that core inflation increases very close to its historical average of just below 1.5% as the ECB expects (see chart 2). The ECB will in our view lower its core inflation forecast in December this year or in March next year which would then be followed by another round of dovish comments from Draghi and eventually more easing.

Further easing could also follow if sentiment in the euro area deteriorate on back of the uncertainty in China and emerging markets. Today’s message from the ECB was that it is too early for the ECB to conclude on whether or not more easing is needed on the back of the latest uncertainty. In terms of timing the amount of data ahead of the October ECB meeting is limited (see timeline below) and we believe it is most likely the ECB will stay on hold until the December meeting and possibly stick to verbal intervention until 2016.

In terms of available instruments Draghi put most focus on the flexibility of the QE programme, as he emphasised it could be extended beyond September 2016 and/or the ECB could increase the monthly purchases. In terms of further cuts in policy rates Draghi said, that the ECB did not discuss whether it had reached the lower bound on policy rates and based on this we stick to our expectations that it is more likely that the ECB will extend its QE purgramme rather than cut policy rates.

The dovish message was well-received by the market with a broad-based rally in fixed income driven by the 5y and 10y segment. We interpret the reaction to the change in the ISIN limits as well as the Governing Counsil judging it ‘premature’ to conclude on the downside effects on growth and inflation expectations as market building up expectations for the QE programme to be scaled up or extended. A signal Draghi clearly wanted to send.

Following up on the change of the is in limit:

1) “The blocking minority” phrase is related to CACs. Bonds issued before 2013 did in general not include CACs. Hence, ECB will be able to by up to 33% in older bonds while the figure could be only 25% bonds issued after.

2) This could have implications for countries where the SMP holding are high – so it is maybe support to the belly of Ireland, Portugal and Spain/Italy.

3) The change to the ISIN limit is a dovish sign from the ECB. ECB is removing restrictions to ensure that the programme can be extended/increased – DRAGHI SAID IT WAS A SIGN – this theme has further to go.

Chart 1: ECB expects inflation below 1% in H1 2016


Chart 2: ECB maintained its high core inflation forecast in 2016


Timeline for data releases and ECB meetings during the rest of 2015