ECB review: less ‘punch in the bowl’ from Draghi
Pernille Bomholdt Henneberg
Senior Analyst, Euro area macro Research
+45 45 13 20 21/+44 20 7410 8157
[email protected]
Anders Møller Lumholtz
Chief Analyst, Fixed Income Research
+45 45 14 69 98
[email protected]
Thomas Harr
Global Head of FICC Research
+45 45 13 67 31
[email protected]
Thomas Hoppe Rosenlund
Graduate, Fixed Income Research
+45 45 14 32 85
[email protected]
8 December 2016
Investment Research
www.danskemarketsequities.com
Important disclosures and certifications are contained from page 17 of this report.
ECB review: less ‘punch in the bowl’ from Draghi
The ECB extended its QE purchases by nine months to December 2017, but reduced the
monthly purchases to EUR60bn from EUR80bn. The lower pace of purchases followed,
according to the ECB, as the risk of deflation has now largely disappeared (the reason why the
pace of purchases was temporarily lifted). President Draghi said the nine-month extension
followed, as the ECB wants to signal a sustained presence and no near-term tapering.
Draghi expressed a very dovish tone during the Q&A and continued to repeat that tapering
had not been discussed. According to Draghi, none of the ECB members want to taper QE, but
the main message was a sustained ECB presence in the markets without distortions. Related
to this, the ECB communicated additional flexibility in case of a less favourable inflation outlook
or a worsening in financial conditions.
The market seemed to ‘accept’ that the lower QE purchases do not imply the ECB is on a
tapering path. This should be seen in light of Draghi’s dovish stance including the comments
that the new inflation projection is ‘not really’ close to the 2% target and that the ECB does not
have the ‘luxury’ to consider lowering its purchases further.
In terms of QE restriction changes, the ECB now permits buying bonds with a yield below the
deposit rate while the maturity range includes the 1-2y. The ECB has thus not lifted the 33%
issue/issuer limit and will continue to follow the Capital Key distribution. On the repo
adjustments, the ECB headlines indicate substantial easing – the details are less upbeat.
1
ECB review: less ‘punch in the bowl’ from Draghi
Looking ahead, we still believe the ECB will announce a third QE extension some time in H2
next year. This should follow as we do not believe inflation will reach a sustained path consistent
with the inflation aim before December 2017. Draghi said the inflation projection at 1.7% in
2019 is ‘not really’ close to the 2% target, implying another extension is likely if the ECB revises
its inflation forecast lower again. We still consider the ECB’s core inflation projection very
optimistic and based on this a lower inflation projection should eventually follow.
The QE extension of EUR60bn for nine months was less than the market had expected,
triggering a fixed income sell-off. The short-end rallied after Draghi opened the door for the
possibility of ‘buying below depo’. Overall, the 2/30 in Germany steepened 10bp. The fact that
the issue/issuer limit was kept unchanged means purchases in Ireland and Portugal are set to
decrease further (deviate more) from what the Capital Key would have suggested. Portugal
widened 20bp to core, while the market reaction in Ireland was more muted.
EUR/USD initially bounced on the ECB announcement but fell thereafter when the market
realized that the policy change was in a more dovish direction than it initially appeared. At the
press conference, Draghi clearly struck a dovish tone, stressing that sustained ECB presence
in markets is the main message. Near term, we see EUR/USD in a 1.05-1.10 range with the
balance of risks skewed towards a break to the downside. As such, EUR/USD is a sell on rallies
within the 1.05-1.10 range. We forecast EUR/USD at 1.05 in 1M and 1.04 in 3M before a
sustained move higher to 1.08 in 6M and 1.12 in 12M.
2
ECB review: less ‘punch in the bowl’ from Draghi
1. QE extension at a slower pace, but this is NOT tapering
2. We expect a third QE extension in H2 17 as inflation is set to stay low
3. Restriction changes: steeper DE curve – less support to PT + IE
4. Repo adjustment details might be less upbeat than the headline
5. Inflation projection at 1.7% in 2019 is ‘not really’ close to the 2% target
3
#1 QE extension at a slower pace, but this is NOT tapering
QE purchases back at EUR60bn as risk of deflation is lower
No members want to taper QE:
The ECB extended its QE purchases by nine
months but at a slower pace of EUR60bn vs
EUR80bn previously. Despite the slower
pace, it adds QE purchases of EUR540bn,
which is more than consensus of EUR480bn
which would have followed from a EUR80bn
extension for six months.
QE purchases at EUR60bn – not ending soon
90
EUR bn
Monthly QE purchases
80
70
?
60
50
40
Draghi made it very clear that this is not
tapering – tapering is not even on the table as
no members want to taper QE. Instead, it is a
way to signal that the ECB will have a
sustained presence on the markets.
30
20
10
0
Jan-16
Jul-16
Jan-17
Potential additional QE extensions
Additionally, the ECB communicated it is
flexible in case of a less favourable outlook or
a worsening in the financial conditions. The
latter could in our view e.g. follow from
increased political uncertainty.
Jul-17
Jan-18
Jul-18
ECB announce QE extension (December)
Current QE programme
Source: ECB, Danske Bank Markets
4
#1 QE extension at a slower pace, but this is NOT tapering
The market is still pricing ECB rate hikes – this is premature
ECB rate hikes still priced too aggressive:
The market initially reacted to the nine month
extension of EUR60bn by pricing in a 10bp
ECB rate hike already in September 2018,
but by day-end the rate hike was again priced
in end-2018, hence unchanged from going
into the ECB meeting.
In our view, a rate hike within two years is
still very unlikely, as we believe the ECB will
extend its QE purchases beyond December
2017. The ECB’s communication that it is
not close to tapering makes the pricing of a
rate hike even more premature in our view.
The ECB still communicates that policy rates
are expected to stay at present or lower
levels well past the horizon of the QE
purchases. The Fed waited 13 months from
ending QE to hiking the first time.
ECB pricing volatility during the day
16 bp
14
ECB dated Eonia swaps
(assuming neutral Eonia is
5bp above deposit rate)
12
10
8
6
4
2
0
-2
Dec-16 Mar-17
ECB
ECB
Jun-17
ECB
Sep-17
ECB
Dec-17 Mar-18
ECB
ECB
Jun-18
ECB
13:00
13:46
14:15
16:00
14:33
Sep-18
ECB
Dec-18
ECB
Source: Danske Bank Markets
5
#1 QE extension at a slower pace, but this is NOT tapering
Still inconsistency between hiking cycle and inflation expectations
Inflation is only priced at 1.0% at end-2019
Lower real yields before ECB starts hiking
2.00%
1.50%
1.00%
0.50%
The market is only
pricing inflation at 1.0%
ultimo 2019 vs. ECB's
projection of 1.7%
0.00%
-0.50%
-1.00%
Dec-13
Dec-14
Dec-15
Dec-16
Dec-17
Dec-18
HICP inflation
Market pricing
ECB inflation forecast (December)
Danske inflation forecast
Source: Bloomberg, ECB, Eurostat, Danske Bank Markets
Dec-19
Source: Bloomberg, Danske Bank Markets
6
#2 We expect a third QE extension in H2 17 as inflation is set to stay low
Inflation will not be on a sustainable path towards 2% in H2 17
ECB does not have ‘luxury’ to lower QE more:
According to Draghi, the ECB does not have
the ‘luxury’ of considering lowering its QE
purchases further, as the economic figures
are not currently strong enough for this.
QE to be extended again given too low inflation
Additionally, the ECB again argued there is no
upward trend in underlying inflation. In our
view, this will continue for a long time as the
wage pressure will remain weak, hence
keeping core inflation below the ECB’s updated
projection.
Based on this, the ECB should not conclude
that inflation is on a sustained path towards
the 2% target at end-2017 and we believe it
will extend its QE purchases a third time,
thereby continuing purchases beyond
December 2018.
Source: ECB, Danske Bank Markets
7
#2 We expect a third QE extension in H2 17 as inflation is set to stay low
Lack of upward trend in core inflation is a concern to the ECB
Core inflation is far from the ECB’s forecast
Philips curve: ECB’s wage forecast is hopeful
ECB 2019
Wages: 2.4%
Unemp: 8.7%
ECB 2018
Wages: 2.1%
Unemp: 9.1%
Core inflation on a downward
trend –
ECB’s projection
remains very optimistic
Source: ECB, Eurostat, Danske Bank Markets
ECB 2017
Wages: 1.7%
Unemp: 9.5%
ECB 2016
Wages: 1.2%
Unemp: 10.0%
Source: ECB, Eurostat, Danske Bank Markets
8
#2 We expect a third QE extension in H2 17 as inflation is set to stay low
No ECB QE tapering or rate hikes before wage growth picks up
Service inflation most important for core
Service inflation dependent on wage growth
Source: ECB, Eurostat, Danske Bank Markets
Source: ECB, Eurostat, Danske Bank Markets
9
#3 Restriction changes: steeper DE curve – less support to PT + IE
Buying below the deposit rate – only an option, not necessity
ECB can buy bonds yielding below -40bp:
The ECB changed its QE restriction to now
permitting purchases of bonds with a yield
below the deposit rate while the maturity
range will include the 1-2y, making a large
amount of German bonds eligible for QE.
QE to be extended again… and again?
Yield
1.05%
1200
0.75%
1000
0.45%
The previous eligibility ‘cut-off’ point has
been hovering around the 5-6y mark on the
German curve recently. Hence the QE
changes enable the ECB to buy the 1-6y
segment from January opening for German
bond purchases for around EUR400bn.
800
0.15%
600
-0.15%
400
-0.45%
200
-0.75%
However, this is only the case if the ECB buys
all bonds yielding below the deposit rate. We
consider this unlikely given the ECB said that
buying below the deposit rate is an option –
not a necessity.
1400
0
0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 32
Years
Germany government bonds (live)
ECB deposit rate
27/09/2016
German bonds acc. amount (r.axis)
Source: ECB, Danske Bank Markets
10
#3 Restriction changes: steeper DE curve – less support to PT + IE
Portugal + Ireland and Buxl victims of the issue/issuer limit
Less purchases in Portugal and Ireland:
The ECB maintained its Capital Key purchase
distribution and also maintained the 33%
issue/issuer limit on bond purchases. In
particular, the latter is going to result in
lower purchases of Irish and Portuguese
bonds as has already been seen.
ECB has already reduced purchases in IE+PT
Monthly PSPP purchases - index 2015 average
180
160
140
120
80
Supra
FR
FI
DE
NE
IE
IT
PT
ES
Oct/16
Sep/16
Jul/16
Total
Aug/16
Jun/16
May/16
Apr/16
Mar/16
Jan/16
Feb/16
Dec/15
Nov/15
Oct/15
Sep/15
Jul/15
Aug/15
Jun/15
Apr/15
60
May/15
Purchases of longer-dated German bonds
are also set to be reduced significantly as we
enter 2017 and the QE holdings in +8Y
Germany approach the 33% issue limit. It
remains an open question whether the ECB
will be willing to buy large amounts below
depo in this scenario and/or whether it could
deviate from the capital key.
100
Mar/15
Based on this, we see risk tilted towards
Ireland widening again vs for instance
France.
Source: ECB, Danske Bank Markets
11
#4 Repo adjustment details might be less upbeat than the headline
Repo adjustment – limited ease of the squeeze in German repo
Limited ease of the squeeze in German repo:
The ECB today opened for the new possibility
to use cash as collateral with the pricing
linked to the deposit rate. Cash can be used
as collateral up to an overall limit of
EUR50bn for the Eurosystem.
Big ‘squeeze’ where ECB has been aggressive
According to the ECB, the changes aim to
enhance effectiveness of PSPP securities
lending and should be very welcome following
the latest pressure on the German repo
squeeze (most extreme from +7y).
However, looking at the details (see next
page) this will, in our view, give only a limited
ease of the squeeze in the German repo.
Source: Danske Bank Markets
12
#4 Repo adjustment details might be less upbeat than the headline
ECB should still be concerned about the squeeze in German repos
The details are less upbeat than the headline:
The EUR50bn additional collateral which can
become available should in isolation ease the
squeeze in the German repo.
Big ‘squeeze’ where ECB has been aggressive
However, the ECB statement also states the
conditions will be at a rate equal to the lower
of the deposit rate minus 30bp (i.e. currently
-70bp) and the prevailing market repo rate’.
Hence, the -70bp will not be a floor but
rather the cheapest level (ceiling) for where it
will be activated.
Source: Danske Bank Markets
13
#5 Inflation projection at 1.7% in 2019 is ‘not really’ close the 2% target
The inflation projection for 2019 is not close to 2%
Still no upward trend in core inflation data:
The key argument for us expecting a third QE
extension in H2 next year is that the ECB
remains too optimistic on inflation, although
the projection for 2019 according to Draghi
is ‘not really’ close to the 2% target.
‘Not really’ close to the 2% target in 2019
The ECB is especially still very optimistic in
its outlook for core inflation despite its view
that there are ‘no signs yet of a convincing
upward trend in underlying inflation’. In our
view, the optimistic core inflation forecast
follows from a hopeful wage projection.
Despite the downward revision to the ECB’s
core inflation projection, we believe it will be
lowered again as core inflation will not reach
1.4% in 2018 and 1.7% in 2019. This would
imply headline inflation will be too far from
the 2% target to end QE at the end of 2017.
Source: ECB, Eurostat, Danske Bank Markets
14
#5 Inflation projection at 1.7% in 2019 is ‘not really’ close the 2% target
A lower ECB core inflation projection but it is still too optimistic
Core inflation projection lowered too little
The forecast has been lowered many times
Source: ECB, Eurostat, Danske Bank Markets
Source: ECB, Eurostat, Danske Bank Markets
15
#5 Inflation projection at 1.7% in 2019 is ‘not really’ close the 2% target
Stronger GDP growth but still not wage pressure to lift inflation
GDP indicators have been strong lately
Not very high inflation projection in 2019
ECBprojections
projections
ECB
ECB
(expected) 2016)
(December
(December
2016
2016
HICPinflation
inflation
HICP
HICP
0.3%
1.2%
0.2%
 1.3% 


(0.2%)
(1.2%)
(0.2%)
(1.2%)
1.5%
1.5%
(1.6%)

1.7%
Coreinflation
inflation
Core
Core
0.9%
1.1%
0.9%
 1.1% 


(0.9%)
(1.3%)
(0.9%)
(1.3%)
1.4%
1.4%
(1.5%)
(1.5%)


1.6%
1.7%
GDPgrowth
growth
GDP
GDP
1.6%
1.6%
1.7%
 1.7% 


(1.7%)
(1.6%)
(1.7%)
(1.6%)
1.6%
1.6%
(1.6%)
(1.6%)


1.6%
1.6%
10.1%
9.8%
10.0%
 9.5% 


(10.1%)
(9.9%)
(10.1%)
(9.9%)
9.5%
9.1%
(9.6%)
(9.6%)


9.2%
8.7%
1.2%
1.5%
1.2%
 1.7% 
(1.2%)  (1.8%) 
(1.2%)
(1.8%)
1.9%
2.1%
(2.2%)
(2.2%)


2.2%
2.4%
Unemployment rate
rate
Unemployment
Unemployment
Wagegrowth
growth
Wage
Wage
2017
2017
2018
2019
Parenthesis are the old ECB's projections (from September)
Parenthesis
Parenthesis are
are the old ECB projections (from September 2016)
*Food
*Food price
price inflation
inflation is
is assumed
assumed higher in 2017-18
Source: Eurostat, Markit PMI, Danske Bank Markets
Source: ECB, Danske Bank Markets
16
Disclosures
This research report has been prepared by Danske Research, a division of Danske Bank A/S (‘Danske Bank’). The author of this research report Pernille Bomholdt
Henneberg, Senior Analyst.
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