Meeting of ECB Governing Council in July – as close to action as they could get

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After the 22 July meeting of the ECB’s Governing Council, the Policy Statement was about as dovish as could reasonably be expected.

  • At this point, it seems President Mario Draghi has (once again) imposed his will within the council and a package of easing measures will be announced in the next couple of meetings.
  • To a large extent, it seems this outcome was largely already priced by the market – indeed, the net effect of this statement and good US economic data was to leave bond yields largely unchanged (even marginally  higher).
  • In coming weeks, the news/opportunities will likely concern the precise design of the package and the consequences for the trade war, which we fear could be material.

  • The council has reintroduced an easing bias into the guidance on interest rates “to remain at their present or lower levels” and has tasked the staff to consider measures that might cushion the blow on the banking system “such as the design of a tiered system for reserve remuneration”.

It seems that there are still concerns on this front, but Draghi was insistent that any rate cut would be accompanied by mitigating elements (although this could come in the form of changes in the TLTRO-iii).  Draghi was keen to reassure the market that there is still some space above the lower bound, arguing that the ECB was not close to the reversal rate. All things considered, it seems more likely than not that the ECB will cut the deposit rate, most likely starting in September, and at this juncture we would estimate the eventual cut will be 20 basis points.

  • The council has introduced a broader conditional commitment to act “if the medium-term inflation outlook continues to fall short of its aim, the Governing Council is determined to act, in line with its commitment to symmetry in the inflation aim” where we should note in particular a(nother) pointed reference to the symmetry of the mandate, which can be contrasted somewhat (and Draghi did in the Q&A) with the standard form of words “below, but close to, 2%.

It transpired that there was a discussion of changing the formal definition of the mandate, with some members in favour of the change, but it appears there was not a majority for this.  Presumably the hawks are only too aware of the implications of such a change on the conduct of policy after Mario Draghi’s mandate ends.

  • The policy statement then followed up by specifying the nature of the response – the council “stands ready to adjust all of its instruments, as appropriate, to ensure that inflation moves towards its aim in a sustained manner” and clarifies further by noting that the Council has tasked the staff committees with “examining options, including ways to reinforce its forward guidance on policy rates, mitigating measures, such as the design of a tiered system for reserve remuneration, and options for the size and composition of potential new net asset purchases.

This statement seems a clear signal that further action could be imminent. The most likely outcome now seems for more stimulus to be announced – probably in September, or perhaps in October.

  • The market pre-occupation is with rate cuts and sovereign bond purchases, but it seems likely to us that the Governing Council will announce a package of measures. An extension of the rates guidance, a more fundamental change in the guidance to signal a change in the reaction function to aim for an over-shoot, a re-calibration of the TLTRO loans and a change in the reinvestment rules are all plausible measures alongside rate cuts and asset purchases.  But the key uncertainty at this point is around the nature of the asset purchases programme that is being devised, given the reference to the “composition” in the statement.
  • The market presumes that a new purchase programme will surely include sovereign bonds. In  fact, the Council did not discuss the contentious questions of sovereign QE: of deviating from the capital key or raising the issue limits. Nonetheless, net purchases of sovereign bonds now seems a reasonable base case – but we highlight that there are other plausible options here, including just expanding the corporate bond buying programme, expanding it to include bonds issued by banks or bonds that don’t meet the current ratings threshold, and even purchasing equities.  However, some of these sound quite remote possibilities.
  • We are not convinced that there is agreement yet on all the details – the modalities of the package, the extent of the rate cuts, the design of the mitigants, the modalities of the package, the assets that will be purchases. Indeed, President Draghi argued that the Council has placed itself in the hands of the committees when it comes to the design of the package, but there were some mixed messages on the precise remit.
  • In terms of the coverage of the economic news in the Introductory Statement and the Q&A, Draghi emphasised that the outlook is getting “worse and worse”, speaking specifically of the manufacturing sector and countries which are heavily reliant on manufacturing, and he concluded that a rebound in growth in 2019 H2 seems less likely (and so no doubt it will appear in the September staff projections).  But as the Introductory Statement noted “activity levels in the services and construction sectors are resilient and the labour market is still improving” and Draghi acknowledged that the risks of recession are still seen as “pretty low” with fundamentals supporting consumption. When it comes to prices, Draghi’s message was clear. “We don’t like what we see on inflation” and in his view, it would be a mistake to be complacent about market-based measures of inflation expectations (striking a somewhat different tone to Board member Benoît Cœuré).

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