ECB to maintain purchases at EUR80bn at the meeting tomorrow – Danske Bank

Senior Analyst, Pernille Bomholdt Henneberg at Danske Bank, notes that ahead of the ECB meeting tomorrow, a rate hike from the ECB in 2018 continues to be priced in with a high likelihood.

Key Quotes

“Currently, the market is pricing in an 80% probability of the first 10bp ECB rate hike already in December next year. At the same time, the market is pricing in inflation at only 1.2% next year, which in our view is too low inflation for the ECB to have tapered its QE purchases and also hiked the policy rate. In other words, we see a market inconsistency reflected in a too high real rate in the short end of the curve.”

“Longer-dated inflation expectations have moved higher but remain too low for the ECB to tighten monetary policy. Medium-term, market-based inflation expectations (5Y5Y inflation swap) have gone from below 1.3% at the beginning of September to above 1.7%. The rising tendency should be very welcomed at the ECB, but looking back at when the 5Y5Y inflation swap first declined below 1.7%, the ECB announced its QE programme due partly to concerns about de-anchored inflation expectations.”

“Political uncertainty is another factor which, in our view, highlights that it is important for the ECB to stay off the tapering and hiking trigger. Although the financial market implications of the Italian ‘no’ in Sunday’s referendum have already been shaken off, there is still an elevated political risk that the ECB has no interest in boosting. If the ECB starts tapering its QE purchases across countries, yields will rise and particularly higher periphery yields could kill the fragile recovery in some of the periphery countries as higher yields would spill over to higher cost of borrowing.”

“We expect the ECB to extend its QE purchases by six months to September 2017 and maintain the purchases at EUR80bn at the meeting tomorrow. While this is close to consensus, we consider it most likely that the ECB will extend its QE purchases again next year as we expect the wage and underlying price pressure to remain too low for the ECB to conclude that inflation is on a sustainable path towards the 2% target.”