The ECB's very gradual edging toward an unwinding of its bond-buying programme continues at a slow pace. Here's a short review of news on ECB policy so far this month:
ECB removes easing bias from guidance on quantitative easing (QE)...
The meeting of the ECB’s governing council on 8 March was, as expected, largely a non-event. However, the ECB did drop its explicit commitment to expand its bond-buying programme if the eurozone expansion falters. Those investors who keep a close eye on the ECB had long since concluded that a sustained increase in the pace or significant extension in the duration of the programme was not really plausible. There are simply not enough eurozone sovereign bonds left for the ECB to buy. So, the removal of the easing bias should have been of no consequence.
...but ECB policy has changed, according to President Draghi
However, the euro spiked higher on the news (see Exhibit 1 below), only for the move to more than unwind by the end of the press conference thanks to slightly weaker inflation forecasts (largely reflecting different assumptions about the path of oil prices) and Draghi’s dilution of any signal in the news. He said that the ECB can still carry on buying “in any case until the governing council sees a sustained adjustment in the path of inflation consistent with its inflation aim”. He dismissed the move as “a backward-looking decision without signals or implications for either our expectations or our reaction function”.Exhibit 1: The euro continues to strengthen against the US dollar (changes in euro/US dollar exchange rate between 2014 and 2018) Source: Bloomberg, BNP Paribas Asset Management, as of 19/03/18 Exhibit 2: changes in euro/US dollar exchange rate on 8 March 2018 Source: Bloomberg, BNP Paribas Asset Management, as of 20/03/2018
ECB's incumbents cannot make commitments for their succcessors
Then, on 14 March, the community of ECB watchers gathered in Frankfurt for their annual get-together. Top of the bill was President Draghi’s address, closely followed by comments by Chief Economist Peter Praet. Many of attendees concluded that the overall tone of the message from Draghi and Praet was dovish. We are less sure.
The basic message conveyed was that the ECB will have to proceed cautiously once the rate-rising cycle begins, not least because the inflation outlook remains uncertain and the exit from the unconventional stance (i.e., QE) is fraught with difficulty. There is nothing necessarily wrong in principle with the ECB trying to provide guidance that the rate path could be shallower than the market currently anticipates. We happen to find those arguments compelling.
However, there is a small problem in practice: neither Praet nor Draghi will be around to make the case for that shallow path during the policy tightening cycle: both are due to leave office in 2019.
The market should only attach a lot of weight to this dovish guidance if it believes that their likely successors share the views of Praet and Draghi or if the current president and chief economist can bind the hands of their successors to vote in a particular way.
Conditions for stopping asset purchases are closer to being met
What matters more, in our view, are the decisions that Draghi and Praet can still take. Here, the message was less dovish. At the margin, both implied that a hard stop of QE in September was now a little more likely than we had assumed. Our base case is that net purchases will continue until the end of 2018.
First, Draghi commented that “net asset purchases remain necessary for now to validate the stimulus that is already priced into key indices of financial conditions and on which the inflation path depends”. But he made it clear that the conditions for stopping are closer to being met. The ECB is becoming more confident that inflation is on the right track to return to target.
Second, Praet described how market expectations for the end of QE had become increasingly aligned with those of the council: “There is a convergence between market expectations and our intended end date, with the optionality”. Describing September as the “intended end date” is important, as was the seeming validation of the first rate rise in the second quarter of 2019.
In short, Draghi and Praet are not pushing back on market expectations and hence financial conditions for the period in which their views still matter; they are trying to nudge expectations further out.
Eurozone inflation falls to the lowest level since the end of 2016
On 16 March, the rate of headline inflation in the eurozone was revised down to 1.1% in the final release of February data from the provisional 1.2%. While core inflation was stable at 1.0%, the pace of core goods inflation was revised down from 0.7% to 0.6%.
Exhibit 3: Eurozone inflation was lower than initially estimated in February (changes in the rate (%) of headline and core inflation 1999 to 2018)Source: Bloomberg, BNP Paribas Asset Management, as of 19/03/18
In our view, this should be the trough for headline inflation, given the base effects, but the anaemic rate of core inflation is likely to anchor the headline rate as we move through the rest of the year. However, the path will likely not be smooth as the usual noise from package holidays and airfares will whipsaw the rate around. Looking through that month-to-month volatility, we share some of the concerns highlighted by Draghi in his speech at the Watchers conference.
No change in the ECB policy outlook over the next 18 months
We remain of the view that the outlook for ECB policy – at least until President Draghi's term ends in October 2019 – remains unchanged and not subject to the usual caveat of massive uncertainty. QE, or net asset purchases, will likely end this year, although reinvestments should continue for some time to come. After that, there should be a pause before the governing council takes the first proper step towards exit by raising rates, most likely in the second quarter of next year.
However, once President Draghi exits the stage, all bets are off. His successor could have a fundamentally different interpretation of the mandate and the merits of different unconventional monetary tools. Under these circumstances, it is very hard to know how fast the unconventional ECB policy measures will be ended or even how it will exit.