ECB: Exit strategy and a modern policy rule – Deutsche Bank

Research Team at Deutsche Bank has built a policy rule to describe the ECB’s reaction function and to infer the future path of monetary policy. 

Key Quotes

“According to our strategists, current market valuations are consistent with QE tapering ending in the second half of next year. Markets seem to price in a deposit rate hike in Q2 2018 and a subsequent MRO hike in Q3 2019.”

“The combination of the ECB projections and our policy rules would suggest that markets are overly dovish. If the ECB Governing Council remains confident about their staff above-consensus projections, markets would have to bring forward (i) an increase in the deposit rate to the second half of this year, (ii) their expected QE termination date to the first half of 2018 and (iii) the first MRO rate hike to Q3 2018.”

“Naturally, using the less-optimistic consensus forecasts, the discrepancy is less accentuated – but markets do continue to appear moderately dovish.”

“We think the ECB will follow a gradual exit strategy:

• June 2017: forward guidance could be changed by dropping the reference to lower rates and the language could be modified to allow the deposit rate to move independently of the MRO rate in the short term.
• September 2017:  the ECB could announce (i) the start of QE tapering in January 2018 and (ii) a one-off 15-20bp deposit rate hike to be implemented by the end of the year.
• Mid-2018: the QE tapering process ends. 
• December 2018: the normal but gradual MRO rate hiking cycle begins.”