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Carsten Brzeski's blog

ECB Preview/Taper test – European style (ING Research Distribution)

In September, the ECB’s Governing Council asked its committees to investigate possible technical changes to the QE programme. Next week’s meeting should come too early for any great breakthrough. Still, we expect ECB president Draghi to lift the veil a bit and open the door for an extension of QE beyond March 2017.

Better than expected. The macroeconomic data released since the last ECB meeting has been better than expected and should confirm the picture painted by the ECB’s staff projections from September. Namely, a gradual, yet weak, economic recovery. Fears of an economic standstill in the third quarter seem to have been premature. Still, as Mario Draghi recently remarked, the fact that the short-term impact from Brexit has been weaker than feared does not mean that there will be no effect.

Can you hear the hawks? Maybe the most interesting development in recent weeks has been the verbal shift of several ECB members towards a somewhat more hawkish tone. President Draghi stressed the ECB’s current forecast that headline inflation would gradually return to 2% by the end of 2018. Other members warned against the unintended risks of maintaining interest rates too low for too long.

Taper tantrum – European style. The slightly more hawkish tone was accompanied by the first rumours of ECB tapering. A Bloomberg story that the ECB was discussing tapering came as a cold shower for many market participants. Contrary to the reaction after the Fed’s first tapering attempts, the increase in bond yields, however, remained limited. Nevertheless, the first tapering test was a good reminder that QE could eventually come to an end, even if this moment is still far away.

Waiting for the committees. Macro developments since the September meeting have not put the ECB in a hurry to present additional monetary actions. Even the scarcity problem of the ECB’s QE programme does not necessarily have to be solved next week. In fact, the possible lack of sufficient supply for bond purchases would only be a pressing issue at the beginning of next year. This means that addressing the scarcity problem will, strictly speaking, only be required if and when the ECB is definitely determined to extend QE beyond March 2017. Or, to put it the other way around, once the ECB addresses the scarcity problem, this would be a clear sign that QE would be extended. Back in September, the ECB had tasked its committees to investigate possible options to address the scarcity problem. We don’t expect the ECB to present a clear plan next week, but at least Draghi could lift the veil a little bit.

Addressing the scarcity problem. The most likely option, in our view, would be to increase the limits on bond issuers and issues from the current 33% to 49.9%. Other options, such as a formal disregarding of the ECB’s capital key in the distribution of bond purchases are politically controversial, while dropping the deposit rate floor for the purchases could harm the profits of national central banks.

Taper test and trial balloon. Another interesting way to address the scarcity problem could be a semantic solution. A smart relabeling. An extension of QE beyond 2017 at a lower or even gradually decreasing monthly pace could be called tapering (to please the ECB hawks) but would also provide the Eurozone with continued stimulus (to please the ECB doves). An elegant solution, Draghi could present this at the December meeting.

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