No ECB QE tapering discussion – we expect QE extension

The ECB kept all policy rates unchanged, maintained its monthly QE purchases of EUR80bn and still intends to end its purchases in March 2017. Regarding the outlook for monetary policy, the ECB repeated that it remains committed to preserving the ‘very substantial degree of monetary accommodation that is necessary to secure a sustained convergence of inflation’. Additionally, President Mario Draghi repeated ‘there are no signs yet of a convincing upward trend in underlying inflation’. In our view, this implies the ECB will not conclude QE can be ended in March 2017.

Overall, we have not changed our view that the ECB will announce a six-month QE extension at the upcoming meeting in December, as the ECB provided little information at today’s meeting. According to Draghi the decision in December will indicate what the ECB is going to do in coming months. This is because the ECB’s assessment in December will benefit from new ECB projections extending until 2019 and ‘from the work of the Eurosystem committees on the options to ensure the smooth implementation of our purchase programme’.

Early in the Q&A session, Draghi made some hawkish comments, as he said the ECB had not discussed QE extension and concluded the extraordinary policy support would not exist forever resulting in higher EUR/USD. However, the market reaction was reversed when Draghi later said the ECB also did not discuss QE tapering or the intended purchase horizon. According to Draghi, an abrupt end to QE was never discussed and was deemed unlikely, which in our view should not be much of a surprise to market participants.

The ECB did discuss negative policy rates and the conclusion from Draghi was they do not hinder the transmission of monetary policy. Related to this, Draghi was asked whether he would rule out raising rates while QE is still in place, to which he replied that the ECB expects them to ‘remain at present or lower levels for an extended period of time and well past the horizon of our net asset purchases’.

On the repo squeeze, which the ECB expressed concern about in its minutes of the September meeting, Draghi basically avoided the question. Instead, he focused on the overall scarcity issue, saying that the discussion was on how to overcome scarcity if it was to become a problem. In our view, this is likely to be discussed further ahead of the December meeting. Regarding changes to the QE restrictions, we believe the ECB could continue to deviate from the capital key without introducing new buying distribution.

Muted reaction in the fixed income market with the long-end rallying as the market was biased towards a hawkish tone on the back of recent ‘tapering fear’. The 30Y Germany rallied 4bp, while the 2Y was roughly unchanged. Portugal has rallied strongly over the past week, on decreasing concerns regarding the DBRS review tomorrow and Draghi added to this that ‘Remarkable progress achieved in Portugal but ambitious reforms are needed, e.g. addressing NPLs that was that was biased towards’.

EUR/USD initially bounced when Draghi said that the Government Council had not discussed an extension of QE. However, it fell back again when he said that they had not discussed tapering of QE either. EUR/USD broke the important level of 1.0950 and we see relative interest and growth expectations as bearish for EUR/USD near term, forecasting the cross at 1.08 in 3M. Medium term, we continue to be EUR/USD bullish, forecasting 1.11 in 6M and 1.15 in 12M on valuation and a eurozone-US current account differential.