Eurozone Monetary Policy October 2016

Eurozone

Eurozone: ECB holds rates, kicks decision on QE program to December meeting

The European Central Bank (ECB) decided to stay the course and made no changes to its monetary policy at its 20 October meeting, matching market expectations. The Bank held the refinancing rate, the marginal lending rate and the deposit facility rate steady at 0.00%, 0.25% and minus 0.40%, respectively. The ECB also maintained its asset purchase program at EUR 80 billion a month and reiterated that the program was intended to run until March 2017 or later, if needed.

The ECB’s stance comes against a backdrop of broadly unchanged economic and monetary conditions since the last policy meeting. The latest indicators suggest that the Eurozone’s steady but lackluster recovery continued in the third quarter and inflation remains at low levels. While inflation rose in September, the uptick was driven by external pressures as energy prices were less of a drag. At the accompanying press conference, ECB President Mario Draghi reiterated that, “[the Bank] remain[s] committed to preserving the very substantial degree of monetary accommodation which is necessary to secure a sustained convergence of inflation towards levels below, but close to, 2% over the medium term.”

Meanwhile, market attention has shifted from the interest rate decision to the duration of the ECB’s quantitative easing (QE) program. The program is set to expire in March, however, it is widely expected that the ECB will extend it to avoid tightening financial conditions while economic momentum remains weak. In the press conference, Draghi kicked the decision down the road and stated that the future of the bond-buying program will be discussed at the 8 December monetary policy meeting, when updated and longer-term macroeconomic projections are available. However, Draghi pointed out that a sudden end to the program is unlikely, meaning that the QE program will likely be unwound slowly when the time comes. Any extension of the program will likely come with a technical modification due to the scarcity of eligible assets such as German Bunds.

At this point, many of our panelists see the ECB extending its QE program past March, however, diverging opinions exist on the duration and size of the program extension. Carsten Brzeski, Chief Economist at ING, sees the current ECB announcement as buying time and adds:

“Mario Draghi’s elegant balancing between tapering and an extension of QE keeps all expectations alive and could have one welcome fall-out: slightly higher long-term rates which will bring some relief to the scarcity problem without panic. At the December meeting, our view is that the ECB will announce an extension of QE until the end of 2017, possibly at a slower pace than the current 80bn euro.” 

Kallum Pickering, Senior UK Economist at Berenberg, sees a smaller extension, commenting:

“We expect the ECB to announce that it will prolong its current €80bn asset purchases by at least three and more likely by six months beyond March 2017. In the second half of next year, we look for the ECB to start to taper its purchases - trying to avoid disruptions will be enough of a reason to go about it gently. “

Meanwhile, our panelist Marco Valli, Chief Eurozone Economist at UniCredit is not expecting immediate tapering of the purchases and explains:

“We remain convinced that the GC will opt for an extension of QE by six to nine months at the current pace. This would require EUR 480-720bn of additional purchasable assets. We estimate that, under current market conditions, raising the ISIN limit from 33% to 50% and applying the deposit-rate restriction to a portfolio of bonds rather than to individual bonds would free a sufficient amount of German paper to make this extension possible.”

While our panelists have divergent views on the ECB’s unorthodox monetary policy decision, there is a strong consensus on the path of interest rates. All of the analysts surveyed by FocusEconomics expect the ECB to keep the policy rate unchanged at the current record-low of 0.00% this year and next.


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Euro Monetary Policy October 2016 3

Note: ECB Refinancing Rate in %.
Source: European Central Bank (ECB).


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