After the Brexit vote and the ECB’s July meeting, most market participants expected the ECB to decide on new action in September. However, the data released over the past two months has been too inconclusive to justify any significant new action. For the ECB, this week’s hardest decision will be whether it dares to do nothing or whether it wants to underline its willingness to act. The option of doing nothing has become more likely.
Too inconclusive. The macro-economic data released since the last ECB meeting has been mixed. The big negative shock from the Brexit vote has not (yet) occurred. Initially, soft indicators for the Eurozone actually increased, giving rise to speculation that the Eurozone economy could remain unharmed. ECB Board Member Peter Praet last week also stressed the “encouraging signs of resilience”. Recently, however, several Eurozone indicators have started to bow, suggesting that it was far too early to draw any conclusions on the possible impact from the Brexit vote, even for the short term.
Difficult times for forecasters. With mixed soft indicators and no hard data for the third quarter yet, conducting the quarterly staff forecasts can definitely not have been easy. Even though the ECB seems to have done some estimates on the potential economic damage from Brexit, we don’t think ECB staff can incorporate them in their forecasts. Normally, the so called “no policy change” assumption is used in these projections, ie, only given events or future actions will be included. Consequently, the projections should remain broadly unchanged from June.
Inflation still invisible. Low inflation and, particularly, the latest drop in core inflation will ring alarm bells again at the ECB. As shown in the minutes of the last meeting, the ECB is increasingly concerned about the lack of any evidence for an upward trend in core inflation. This upward trend seems to be key in the ECB staff’s projections of increasing headline inflation in the next two years. Without this increase in core inflation, all the inflation projections might soon be subject to downward revision. Therefore, the ECB staff’s take on core inflation in the projections will in our view be the single most important element to look at.
Case for action this week has become weaker. The case for additional monetary stimulus at this week’s meeting has become increasingly weak. At the same time, the ECB seems to be increasingly aware of the adverse effects of its current monetary policy stance. Therefore, the hurdle to either deliver a bit more of the same (rate cuts, extensions to QE) or enter more unchartered territory (purchasing of bank debt or stocks) has increased. This does not take away that we still see the ECB extending its QE until at least the end of 2017 (from March 2017 currently) later this year. Further rate cuts do not look likely.
The scarcity problem. The expected slowdown of QE purchases over the summer has given rise to new speculation about some technical tweaking of the QE programme, currently the most pressing problem for the ECB. The most likely options to tackle it are an increase in the threshold of purchases per issuance from 33% to 50%, or a drop of the deposit facility rate floor. In our view, reducing the deposit rate floor is the least controversial and therefore most likely option. Even if it is not sure whether the ECB will already announce a full adjustment, we expect Draghi to give at least some hints regarding the scarcity problem at the press conference.