Carsten Brzeski's blog

ECB meeting – Lower but longer

The ECB surprised markets today by announcing an extension of its QE programme, albeit at a lower monthly pace. Lower but longer, instead of extend and pretend, has given markets something to chew on.

At today’s meeting, the ECB decided on several changes to its QE programme. Currently at EUR 80bn per month, the ECB will cut the monthly purchases down to EUR 60bn per month from April 2017, lasting at least until December 2017. In addition, the ECB announced some technical tweaks: i) the maturity of public sector bond purchases will be extended to 1 to 30 years (currently 2 to 30 years); ii) the deposit rate floor is no longer a binding yield limit for QE purchases. These changes are exactly the combination of extending and tapering that many market participants thought would not yet happen, as it could risk an unwarranted increase in bond yields.

During the Q&A session, ECB president Draghi had difficulties sending a very clear message to markets on how to read today’s message. Throughout the press conference, he sounded more and more dovish. Draghi emphasized the fact that QE could be stepped up again if need be and stressed that the inflation forecast for 2019 is still clearly below 2%. He also said that the ECB did not discuss tapering. In fact, according to Draghi, today’s measures could not be labelled tapering. His definition of tapering was a gradual reduction of QE all the way to zero.

As regards the outlook for growth and inflation, the ECB’s macro-economic assessment hardly changed compared with the October meeting. The ECB still expects a very moderate and dampened recovery in the Eurozone with risks tilted to the downside. At the same time, headline inflation is expected to increase, almost exclusively on the back of base effects. The broadly unchanged take on the economy was also reflected in the ECB’s staff projections which expect GDP growth to come in at 1.7% in 2016 and 2017 and 1.6% in 2018 and 2019, while inflation is expected to increase gradually from 0.2% in 2016 to 1.3% in 2017, 1.5% in 2018 and 1.7% in 2019.

Returning to the QE decisions, Draghi stated that the ECB had discussed two proposals today: one to extend QE by six months at the current pace of EUR 80bn and another one to extend by nine months at a slower pace of EUR 60bn. The decision to choose ‘longer but lower' was in our view a compromise resulting from increased pressure from the ECB hawks to stop, or at least reduce, QE. Whether it was a wise decision or whether the ECB could end up in a taper tantrum like the Fed did in 2013 remains to be seen. On substance, today’s announcement should not lead to a taper tantrum as in fact the sum of announced stimulus is higher (9 times EUR 60bn) than in the scenario expected by markets (6 times EUR 80bn). In addition, let’s not forget that from March 2017 onwards, the ECB will also start to reinvest the principal of maturing QE-bonds. The actual stimulus to the economy will therefore be higher than EUR 60bn anyway. However, all of this is possibly contradicted by the psychological effect of changes to QE.

All in all, while at least at first glance, today’s decisions looked, walked and quacked like tapering, ECB president Draghi gave his best to convince everyone that it is not tapering. We tend to believe him, but whether markets will do so as well or rather give the ECB its very own taper tantrum remains to be seen.