ECB – to ease or not to ease that is the question
Traders can expect volatility with tomorrow’s European Central Bank (ECB) rate decision and subsequent press conference. This will be President Draghi’s second to the last meeting before relinquishing his role to Christine Lagarde. Is Draghi sure that all easing tools should be readily deployed now or in possible stages? Would he wish to leave incoming President Lagarde to make some of the longer-lived decisions? Or act now with her approval? Will Draghi be able to twist enough arms on the Governing Council, given the opposition to significant stimulus from Germany, the Netherlands and France? Is the ECB technically ready to roll out multiple forms of stimulus and along what timeline?
A deposit rate cut is on the table. Keen market watchers expect a 10bps reduction to -0.5% whereas consensus stands at 10 or 20bps. A smaller reduction now could trigger a further reduction later if not done in one fell swoop. Tiering of reserves, below which negative rates may not apply, is possible to mitigate some of the damage done to bank profitability and the lending cycle against Draghi’s points about the benefits.
What Could QE Look Like
The grander issue is whether the ECB is ready to roll out another wave of quantitative easing. If so, how much will it purchase, over what time horizon, and across what mixture of assets? The ECB’s self-imposed limit of 33% remains higher than the current share of just under 30%. Assuming a moderate pace of growth in eligible marketable assets, hitting the 33% limit by the end of next year would afford room for monthly purchases on the order of about €34 billion per month if the purchases began in early January which would imply a smaller flow than prior QE exercises. A longer-lived program perhaps starting earlier would result in lower monthly purchases if the ECB stayed within the 33% limit. A higher purchase target would require raising the 33% limit. This is subject to at least equal parts of politics and economics in the driving considerations.
ECB & QE Effectiveness
Ultimately QE will do little to address the root of the problems in the Eurozone, which is the lack of credit demand. For instance, the money multiplier effect in the Eurozone has been declining for years. However, surveys indicate that demand for credit from businesses and households have also been trending lower as well despite the availability of cheap credit. Even with the move lower in real yields, gross savings for households have been rising and not falling. Prior rounds of QE have done little to solve this problem.
ECB’s QE & The Euro
The final question is, wouldn’t QE help to weaken the EUR? Yes, even if the ECB has said it doesn’t target the exchange rate. However, it’s interesting to note that despite prior rounds of QE, net portfolio investment has been less harmful (meaning that flows have been EUR supportive) over the past few years. This has helped to offset the downward effect on the EUR from lower domestic yields. Market watchers doubt a fresh round of asset buying is enough to reverse inward flows.
Prices remain in a consolidation phase under 1.1075/1.1105 resistance. This price action continues to appear corrective after the impulsive reversal from 1.0930 wedge support. As such, look for further recovery while over the 1.1020-1.0975 region, with a rally through 1.1115 opening the wedge highs in the 1.1250-1.1315 region. While the potential is there for the entire process from September to be completing around 1.0930, for a move back towards 1.1600-1.1800, more price action confirmation is required to suggest that this is the case. A decline through 1.0975 and 1.0930 would negate this optimism, with 1.0815 next support below. If seen, we would again look for signs of a base developing around that lower level.