New cycle lows in Eurozone inflation along with disappointing ISMs across various nations raise the probability of a dovish ECB meeting tomorrow, in Citi’s view. However, as Deutsche expands upon, they do not see an obvious trigger for “actual” policy easing in the data and events since the last ECB Council meeting and any “action” will take the form of words, not deeds. Despite all the hope in the world, Deutsche warns there would have to be a substantive deterioration relative to current forecasts to elicit an asset purchasing/QE response from the ECB. Instead, more comments on Euro strength, stronger forward guidance, confirmation of the magic of OMT are more likely but so far the market is absolutely calling Draghi’s bluff and saying ‘put-up-or-shut-up’ especialy in terms of EUR strength.
The FT does a great succinct explanation of where we are and what expectations are…
Citi seems a little more hopeful for a dovish ECB meeting and lays out a few reasons why (and what that ‘dovishness’ might look like)…
The chances of dovish ECB meeting have increased in our view after HICP inflation hit new cyclical lows in March and excess liquidity drain pushed money market rates higher again. The ECB could deliver a dovish statement and comments focusing on euro’s recent strength; stronger forward guidance and measures that could fuel expectations of more unconventional policies like a suspension of SMP sterilization and an FLS-program. With markets taking euro shorts off the table, EUR could come off again in the wake of the ECB. EURUSD could correct lower still in the run-up to NFP. Unchanged ECB could lead to further short covering pushing EUR close to recent highs against majors.
The short squeeze in EUR could continue for now despite weaker HICP print for March as markets remain wary of potential disappointments ahead of the ECB. This also means, however, that market positioning need not stand in the way of more EUR weakness by the time of the meeting. We think that President Draghi could surprise on the dovish side and trigger renewed move lower in EUR.
Reasons for the ECB to be more dovish in April than in March/Feb:
1/ Weaker than expected March HICP – Temporary factors may have played a role (e.g. early Easter boosting March inflation in 2013) and a payback in the form of stronger inflation print maybe due in April. That said, the March print goes against ECB’s expectations of low but stable inflation ahead. In addition, core CPI corrected to the downside again reversing previous increase (Figure 1). Recent history would suggest the ECB has responded to cyclical lows in HICP inflation by cutting rates last May and November. Core CPI revisited levels that were associated with ECB action in the past as well. We think that President Draghi could highlight on Thursday that downside risks to inflation have grown of late. A rate cut (not Citi’s central case) cannot be excluded either.
2/ The drain of Eurozone excess liquidity is pushing money market rates higher again highlighting the need for more action in the form of suspended SMP sterilization (Figure 2). Credit crunch remains a worry and sentiment indicators came off their recent highs in March in part because of recent weakness in Eurozone’s main trading partners. It would be difficult for the Governing Council to argue that growth and the credit outlook could improve significantly from here. We think that President Draghi could send strong signals that a suspension of SMP sterilization or FLS program are now more likely.
What would constitute a dovish ECB-outcome:
1/ Clear indications that the inflation outlook has deteriorated in March and signals that it could deteriorate further from here especially if EUR-appreciation persists.
2/ Concerns about the lack of credit growth in the Eurozone and worry about the weaker global recovery could add to the dovish ECB tone.
3/ Measures that could include a 10-15bp refi rate cut, a suspension of SMP sterilization and/or FLS-type of program. The latter two could be perceived to signal that the ECB is willing to consider additional unconventional measures like QE and LTRO.
4/ Stronger forward guidance and indications that the council has discussed measures like QE or negative deposit rates at this meeting.
And Deutsche Bank notes the hurdle to policy action is higher than they thought.
The ECB is in a policy ‘dead zone’. There are some easy policy options, like a refi rate cut or ending the sterilization on SMP. But the returns on these policies are small and hardly commensurate with fighting deflation, if it were deemed to be a risk. Jens Weidmann’s comments on QE drew a lot of attention this week. The heart of his message is that the Bundesbank is intellectually ready to contemplate QE. This in itself is an important stepping stone. This means that should the need arise, the political or “theological” hurdles to QE should not be overstated. The level of insurance we have from the Eurosystem is high, if things turn sour. This does not mean that QE can at this stage be a baseline expectation, but asset purchasing of some form is definitely a non-negligible risk this year. We can fairly easily see the central bank being dragged into QE, rather than enthusiastically and preemptively embracing it.
Beyond dovish rhetoric, we are not expecting the ECB to ease policy in April. The lessons from the last couple of months are that the ECB is difficult to ready and the hurdle to easing policy is high. The ‘easy’ policy options like a refi rate cut or ending SMP sterilization are hardly commensurate with fighting deflation even if it were deemed a risk. On the other hand, the major policies like ABS purchasing, targeted liquidity, negative deposit rates and asset purchasing/QE each have their own complexities and costs. In our view, the data and events since last month do not give the ECB reason to re-assess the costs and benefits.
For now, ECB policymaking will remain largely in the verbal arena. We can imagine a twin track communications strategy emerging from the April press conference.
First, there is the “de facto loosening” argument. Because of spare capacity, the ECB says it will leave policy on hold further into the recovery. All else unchanged, this also moves interest rate differentials in favour of euro depreciation. The virtue of policy inactivity will be pushed further by reference to the AQR/EBA exercise: a successful exercise improves the monetary transmission mechanism, adding more “de facto” loosening. Second, we expect ongoing allusion to policies like negative deposit rates and asset purchasing/QE.
If the euro exchange rate were to rise, a negative deposit rate might materialize. Comments from both Weidmann and Liikanen this week gave the option renewed focus. But having managed to avoid a negative deposit rate so far, one wonders whether the ECB will ever have the appetite for it. The imponderables might be too great — what happens if even one systemically relevant institution is not technically ready to implement such a policy and financial stability is threatened?
There would have to be a substantive deterioration relative to current forecasts, we would argue, to elicit an asset purchasing/QE response from the ECB. One trigger to have in mind would be if the range of the ECB staff inflation forecasts at the end of the 3 year forecast horizon lay completely below the “below but close to 2%” target. At the moment, the upper end of the range is about 2.3%. To move this below 1.9% will require either a strong shock or time for a slow erosion of expectations. In the absence of the former — Ukraine does not yet qualify — it will take time if QE is to emerge. The next re-assessment of staff forecasts takes place in June. Even that may be too soon.