ECB: Lower but longer - Rabobank

Research Team at Rabobank, notes that the ECB announced an extension of its QE program until December 2017 while keeping interest rates unchanged and the key reason to extend policy was that the Governing Council sees “no signs yet of a convincing upward trend in underlying inflation”.

Key Quotes

“The snag in decision – as always – was in the details and, overall, we would argue the message had a slightly hawkish undertone.”

“This was certainly the case in the eyes of the bond markets. Although the Eurodollar actually fell by more than 2 big figures following a very short-lived spike right after the policy announcement, sovereign bond yields traded notably higher in the aftermath of the press conference (although the market gyrated quite a bit, suggesting that the market had quite some difficulty in assessing the overall impact of the ECB’s policy decisions); sovereign spreads generally widened, Italian and Portuguese bonds in particular.”

“The ‘hawkish undertone’ in the message was largely because the Governing Council has decided to adjust its monthly purchase amount down to EUR60bn starting from April. So one could argue that had the ECB chosen to continue purchasing EUR80bn until September 2017 (this was our base case and, as a matter of fact, the other option that had been on the table according to Mr. Draghi), the total amount of purchases until end-2017 would have been around EUR107bn higher (this assumes that they would have started a gradual taper starting from October next year).” 

“According to Mr. Draghi, there were two considerations to return to 60bn as from April 2017. Firstly, because things are now looking slightly better. Indeed, the ECB President highlighted that the outlook for inflation was now broadly similar to what it was when they started the QE program in early 2015 and deflation risk is now seen as low. We think it is no coincidence that the 5y5y inflation swap forward is more or less back to the levels (slightly under 1.7%) where it stood at the end of 2014. At the same time, the ECB is still far from reaching its inflation goal, and so a second reason for the adjustment is that this would allow the ECB to show a sustained presence in financial markets and at least until end-2017 without “distorting prices” (and, hence, to avoid supply shortages).”