ECB decides net asset purchases to cease at end-2018

Today’s ECB decisions and communication featured new details on the future of Euro area monetary policy. First, the ECB announced – subject to incoming data – that its monthly APP purchases will continue at a reduced pace of EUR15bn per month after September and until the end of December, after which net asset purchases will end. Second, the ECB updated its forward guidance on policy rates: rates will remain at their present levels at least through the summer of 2019 (a ‘date dependent’ guidance) and “and in any case for as long as necessary to ensure that the evolution of inflation remains aligned with the current expectations of a sustained adjustment path” (a ‘state dependent’ guidance). There was no update to the language around APP reinvestments. These announcements came earlier that we (and others) expected – in June rather than July – yet the content is relatively close to our long-held view of the monetary policy outlook: asset purchases will cease at end-December and the first rate hike is likely to come only in the second half of 2019, for example at the October meeting (our forecast, which we leave unchanged following today’s announcements). We read the ECB’s enhancement of its rate forward guidance as dovish relative to market expectations, since it implies policy rate increases at the June or July meetings in 2019 are unlikely. our view is summarized below,

1. The Introductory Statement showed that the ECB maintains a broadly positive view on economic growth despite recent weakness in the data flow. The Introductory Statement maintained that the risk to the outlook remains balanced, even if downside risks related to global factors have increased, related to protectionism. The staff macroeconomic projections showed a 0.3pp downward revision to the 2018 growth forecast, but no changes to the 2019 and 2020 forecasts. This was broadly in line with our and the broader market expectation.

2. On inflation, the Introductory Statement contained some innovations, including the sentence that “while measures of underlying inflation remain generally muted, they have been increasing from earlier lows” and that “domestic cost pressures are strengthening amid high levels of capacity utilisation, tightening labour markets and rising wages”. The Governing Council sees uncertainty over the inflation outlook as having decreased. Underlying inflation is still expected to “increase gradually over the medium term” subject to the ECB monetary policy measures. The staff macroeconomic projections showed a 0.3pp upward revision to the 2018 and 2019 inflation forecast to +1.7%. This was somewhat higher than our expectations. The 2020 forecast was left unchanged at +1.7%, as expected. The core inflation forecast was raised 0.1pp for both 2019 and 2020, a touch more than we anticipated.

3. The Introductory Statement noted that the risk of persistent heightened financial market volatility warrants monitoring. Mr. Draghi noted that there had been some moderation in the past two weeks and that the issue had been contained to Italy. Mr. Draghi argued that this did not reflect redenomination risks.

4. The path of net purchases under the APP now embodies a fall in the pace to EUR15bn per month in October, November and December. This amounts to EUR45bn in Q4, slightly higher than the cumulative amount under our linear taper assumption. The ECB stated explicitly that it will stop net asset purchases by end-December. The opt out clause is that this is ‘subject to incoming data confirming the Governing Council’s medium-term inflation outlook’. In our view, surprises in the data flow would need to be substantial to extend the APP. The hurdle to continuing asset purchases into 2019 is high.

5. The most significant news today relates to the policy rate forward guidance. The new guidance offered by Mr. Draghi today is both date and state dependent. The ‘date’ element of this guidance is that the ECB expects policy rates to remain at their current levels ‘at least through the summer of 2019’. This replaces the ‘well past’ guidance and is relatively specific in terms of ruling out June or July hikes (which, under the market interpretation of ‘well past’ as around six months, were previously seen as possible dates for action). Yet, when asked about the date guidance, Mr. Draghi carefully avoided ruling out a hike in September in his remarks at the press conference and has consciously retained some flexibility about when “the summer” ends. If necessary, the ECB could update this type of calendar guidance in the future if it thinks a lower market-implied policy rate path is warranted. The ‘state’ element of the guidance refers to linking the first rate increase to the path of inflation (which must be ‘aligned’ with the Governing Council’s current expectation of a sustained adjustment in the path of inflation). This criterion appears very subjective to the Governing Council and allows for a great deal of flexibility. There was little guidance about the pace of hikes that would follow the first rate increase: Mr. Draghi stated at the press conference that the timing and nature of eventual rate hikes had not been discussed at this meeting. We recently analysed the future path of ECB rate increases.

6. We think  it remains unchanged after the June meeting: We expect the APP to end by end-2018. We continue to expect the first rate hike in the second half of 2019, for example at the October meeting. Once the ECB starts to hike we expect an annual pace of hikes of around 40bp-50bp.