Research: Muddy ECB minutes amid questioned commitment

The ECB minutes from the September meeting released earlier today showed all Governing Council members (GC) wanted to act, but disagreements on how to act. Markets still question the ECB's ability and willingness to do whatever it takes.

We do acknowledge the need for action by the ECB given the low inflationary outlook, but troubles lie ahead, with subdued economic and inflationary momentum, geopolitical risks and no sizeable fiscal support in sight. Inflation is expected to stay stubbornly low at least until the end of next year.

We expect the ECB to stay side-lined at the 24 October meeting, but the recent fall in inflation expectations increases the probability of further action in the December meeting (or early next year) by the ECB – although it is still unclear what such measures would entail, and the minutes didn't give any new indication.

ECB minutes

The ECB minutes released today from the 12 September meeting carried the tone of an ECB unanimously agreeing to act, but uncertainty about how to act. Some arguments were put forward regarding substituting the effect of the measures, rather than the usual complementarity of the policy tools, where particularly some argued for a larger rate cut and no QE. The minutes also carried a tone of the ECB needing to act because of markets having already taken into account further easing, in particular given the weak economic outlook. On the economic outlook, ‘Several members were arguing that, despite the revisions, the baseline scenario in the latest ECB staff projections was still too optimistic', which clearly is a concern as the already optimistic projection takes for granted easier financial conditions. The staff projections do not reflect a no-deal Brexit or a US-China trade collapse, which do increase the risk of further policy responses should they happen (not our baseline). That said, the tone of the minutes does not indicate an ECB about to act imminently.

On the restart of QE, the minutes show that the ECB launched it in order to complement the other policy measures and also due to market expectations that had already built up. It was further noted that its purpose was also to avoid the loss in duration of the already existing portfolio holdings. On the much debated potential break of the ISIN limits, they also assume easier fiscal policies, which means the ECB assumes an increasing stock of purchasable assets. This is not a view we share, see also our Government Bond Weekly here. Finally, a ‘number of members... not sufficient strong to restart QE'. Reservations were also expressed about QE, for if the open-ended EUR20bn did not lift inflation, then more would be demanded by markets.

The outlook for policy changes remains blurred, with starkly opposing views and limited scope within the original toolbox. The FT reported earlier today that the governing councils decided to overturn the recommendation by the monetary policy committee on restart of QE, but the minutes did not indicate that. With growth risks still elevated, the ECB saw the inflation outlook as subdued at the 12 September meeting and they are getting more and more challenged by the expectations for low inflation.

Far from target – challenged ECB

The ECB is getting gradually more challenged and has been since the 12 September meeting, as the growth outlook has been weakening slightly and inflation expectations have declined markedly: they currently hover around record low levels (5y5y inflation swap at 1.16% currently). The ECB's at first bold, but non-committable package according to markets, has failed to lift market expectations as public disagreement has questioned the ECB's commitment, and potentially also its ability, to lift inflation back to target. The ECB GC unanimously also acknowledged that fiscal policies were the main tool via growth friendly fiscal initiatives, but Germany remains reluctant to loosen the brake of fiscal policies.

To our surprise, the ECB is still not worried about de-anchoring inflation expectations, although they carefully reiterate ‘re-anchoring' of inflation expectations at levels not compatible with the mandate. We believe that the limited policy response within the current framework partly reflects that view.

Public cacophony limits stimulus impact

The public cacophony and discord with the official policy line dents the ECB's ability to convincingly lift inflation, illustrated by the doves' (Draghi, Lane, Rehn) continuous repetition of this package being adequate to lift inflation which is being counterweighted by the hawks' (Knot, Weidmann, Coeuré) opposition against it. We believe the ECB was right in launching a package due it its mandate, but we were left disappointed with the details. With the ECB's conventional toolbox looking increasingly empty, the ECB's commitment to think even more unconventionally should eventually also include measures that stimulate the demand side of the economy. More supply side measures have little effect as financing conditions are already very loose in the euro area

Looking back on the previous weeks, the disagreement with the package has been quite clear. In the aftermath of the September ECB meeting, media stories suggested wide disagreement with the policy actions, where at least seven governing council members have been opposing the package, but up to 12 have had reservations with the package. We have also seen, an to our knowledge, unprecedented move by the Dutch Klaas Knot opposing the package with a statement on the Dutch central bank website where he coins the package ‘disproportionate' to the current economic conditions. Also following the decision to stimulate the economy, ECB board member Sabine Lautenschläger resigned, in what can only be interpreted as disagreement with the package as she has been in long-standing opposition to the bond purchases.

Inflation outlook

The details of the recent inflation dynamics have shown that the ECB's hope continues to rest on service prices. While it might see a slight lift in the coming months as the drag from package tours abates, it alone cannot trigger a sustained rebound in realised or projected market expectations for inflation. This remains a key reason why we still do not expect core inflation of more than a mere 1.1% on average next year. Service price inflation is still too low to compensate for the drag from the goods side – making the ECB's 2% inflation target seem as elusive as ever.

Further monetary policy accommodation will be challenged

The relatively widespread disagreement with the latest package limits the room for manoeuvre in the near term. This is clearly illustrated by the ECB's vice-president Luis de Guindos' interview yesterday, when he said that a package should only be used once a year and should not be changed often as that undermines its effectiveness. We see the ECB being side-lined at the October meeting, but the recent fall in inflation expectations raises the probability of further action in the December (or early next year) by the ECB – although it is still unclear what such measures would entail. Fiscal policies would be welcomed, however at current stance and judging from the 2020 budgets released so far, we do not expect fiscal policies to play any meaningful role in lifting inflation.

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