Thursday, December 3, 2015

ECB gifts disappoint after unwrapping

Santa Mario did not turn into the Grinch, the Christmas monster. However, his long-awaited early Christmas afternoon left many market participants disappointed like small kids who receive less and smaller presents than expected on Christmas eve. At its long-awaited meeting, the ECB today cut the deposit rate to -0.3%, from -0.2%, while leaving all other interest rates unchanged. In addition, the ECB decided to extend the deadline of QE purchases to at least until March 2017, from earlier September 2016, and to introduce other measures, broadening the scope of the monthly purchases. For the first time in a long while, ECB president Draghi underachieved and delivered less than the market consensus had expected. As a result, the euro appreciated and bond yields increased immediately after the policy decision. So what exactly did the ECB decide? Basically five things: i) a 10bp cut in the deposit rate; ii) an extension of the formal deadline of monthly QE purchases to at least March 2017, from earlier September 2016; iii) reinvestments of the principal payments of the securities purchased “for as long as necessary”; iv) the inclusion of regional and local government bonds in the monthly purchases; and v) an extension of fixed-rate tender procedure and full allotment for refinancing operation until the end of 2017. What the ECB did not announce was a bigger cut of the deposit rate, a cut in the refi rate or an increase of the monthly asset purchases. The discrepancy between what the ECB did and did not announce raises the question of the ECB’s ratio behind it and the arguments. Looking at the ECB’s macro assessment, it looks as if almost unchanged growth and inflation forecasts as well as a positive assessment of the impact from QE up to now laid the grounds for the ECB’s rather reserved policy reaction. In more detail, ECB staff now expects GDP growth to come in at 1.7% next year (unchanged) and 1.9% (from 1.8% in September) in 2017 and inflation to accelerate to 1% (from 1.1% in September) next year and 1.6% (from 1.7%) in 2017. The underlying story is still the same one of a gradual recovery with downside risks to growth and inflation. According to Mario Draghi, all ECB measures taken so far have increased the inflation forecasts by 0.5 percentage points for 2016 and 0.3 percentage points for 2017. They also boosted GDP by 1 percentage point over the period 2015 to 2017. Moreover, the ECB’s decision to deliver only a very bare minimum of additional monetary stimulus indicates that the hawks at the ECB are stronger than many market participants had thought and that the ECB itself was surprised by the latest resilience of the Eurozone economy and the estimated positive impact of QE so far. Looking ahead, today’s decision still leaves all doors open for more monetary stimulus, in case the outlook for both growth and inflation were to worsen again. In the short term, however, it leaves the destiny of the euro exchange rate mainly in the hands of the Fed. For ECB watchers, today’s meeting was an important lesson not to take Draghi’s overachieving for granted. All in all, today’s ECB meeting, which was expected as an early Christmas present party, turned out to be a bit of a disappointment, maybe better matching the current Zeitgeist in the Eurozone: no copious and excessive gift party but more introvert modesty.

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