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09 Mar 2016
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 Wednesday 09 March 2016

PM Bulletin: ECB look-ahead

 

 

Ahead of the European Central Bank (ECB) meeting in early December last year I wondered, as did many others, if the central bank would deliver when it came to market expectations for additional stimulus measures. It didn’t. ECB President Mario Draghi announced an extension to the duration of the bond purchase programme but held back from increasing the size beyond the original €60 billion per month. The immediate result was a sharp rally in the euro and a sell-off in global stock indices. 

The reason I bring this up is that Mr Draghi had previously highlighted the significance of that particular meeting. Back in October he said the ECB’s Governing Council had discussed expanding its programme of quantitative easing and that December would present the best opportunity for making an informed decision concerning further stimulus. Then in early November Mr Draghi said that “signs of a sustained turnaround in core inflation have somewhat weakened.” A prime reason for investors to expect more from the ECB than it actually delivered.

Once again the ECB President has built up market expectations for further monetary easing. The day after the ECB’s December meeting (which proved to be so disappointing for investors) Mr Draghi insisted that: “There is no particular limit to how we can deploy any of our tools,” and: “There is no doubt that if we had to intensify the use of our instruments to ensure that we achieve our price stability mandate, we would.” After January’s meeting Mr Draghi told reporters at a press conference that downside risks had increased at the start of the year. "It will therefore be necessary to review and possibly reconsider our monetary policy stance at our next meeting in March."

As Yogi Berra once said, it feels like déjà vu all over again.

Low inflation and tepid growth continue to weigh. Euro zone CPI has dropped back into negative territory, raising fears that deflationary pressures are once again taking hold across the area. February’s headline CPI (including food and energy) came in at -0.2% annualised. Meanwhile, core CPI (excluding food and energy) dipped to +0.7% year-on-year from +1.0% previously. This suggests that the decline in energy prices is spreading to the prices of other goods and services. The news was a blow for the ECB who are desperate to counter deflationary pressures.

But what is the expectation when it comes to further stimulus?  Another cut in the deposit rate looks likely. This is the rate that the ECB charges financial institutions for lodging funds with them overnight. By making this an unattractive proposition, the ECB hopes that such funds will flow back into the economy as banks and others look to get higher (but riskier) returns elsewhere. But another cut will put further stress on Euro zone banks as lending/borrowing margins are compressed. This won’t be good news for a sector which is currently experiencing difficulties.

Investors also expect the ECB to extend the duration of its QE programme for a second time, potentially signalling that it will be unlimited. But most importantly, many anticipate that the bond purchases programme will be increased from €60 to €70 or perhaps even €80 billion per month. 

So there are high expectations placed on the ECB. If Mr Draghi comes up short, maybe due to resistance from other members of the Governing Council, then once again we can expect a sharp rally in the euro and a swift sell-off in equities. Quantitative easing may be proving to be increasingly ineffective, but empty rhetoric is even worse as far as the markets are concerned.

 
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Spread Co is an execution only service provider. The material on this page is for general information purposes only, and does not take into account your personal circumstances or objectives. Nothing in this material is (or should be considered to be) financial, investment or other advice on which reliance should be placed. No opinion given in the material constitutes a recommendation by Spread Co Ltd or the author that any particular investment, security, transaction or investment strategy is suitable for any specific person.

 

Posted by David Morrison

Category: PM Bulletin


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