Eurozone : ECB to stay dovish “as long as necessary”
- The ECB cut deposit facility rates and kickstarted QE on Thursday
- Inflation and growth projections were lowered
- Open ended nature of the QE might need a review of investment ceilings
- Outgoing ECB chief called on governments will fiscal space to act
From “whatever it takes” to “as long as necessary,” outgoing European Central Bank chief Mario Draghi followed up with his promise of delivering monetary stimulus on Thursday. This marks the second last policy review of his term. The decisions were backed by a majority in the Council but was not unanimous.
Economic assessment: Reflecting the Governing Council’s concerns, growth and inflation projections were lowered. 2019 GDP is now seen at 1.1%, 2020 at 1.2% and 2021 at 1.4%, effectively lowering 2019 by 10bps and 2020 by 20bps compared to June.
Inferring from ECB’s comments, the baseline assumptions factor in an orderly Brexit and non-escalation in trade wars. Inflation was also dialled down to 1.2% in 2019, 1% in 2020 and 1.5% in 2021 (vs June’s 1.3%, 1.4% and 1.6% respectively).
Policy decision: Citing the weak economic outlook, benign inflation trajectory and urgency to re-anchor inflationary expectations, key measures included:
• Open-ended forward guidance, not to be calendar year based
• Cut the deposit rate by 10bp to -0.5%
• A tiering system where the exempt tier is remunerated at 0% and applies to reserve times six. Multiplier and rates can be changed over time
• Asset purchases will be restarted at EUR20bn, starting from November, without the mention of any end-date.
• The third tranche of Targeted Longer-Term Refinancing Operations (TLTRO) will be repriced and incentivized for banks to lend. Maturity of these loans have been extended to three years.
Policy outlook: The combination of measures announced on Thursday largely delivered on the ECB chief’s dovish guidance. Draghi also pushed through against significant opposition, particularly on restarting QE. We note that the latter has been left open-ended, but without any changes in the underlying thresholds, namely the 33% cap on the member countries, amongst others. This suggests that to be materially ‘open-ended, a review of the thresholds might be necessary within a year.
Mr. Draghi was forthright in calling for fiscal stimulus, especially with countries with the ‘fiscal space’ to act in an effective and timely manner. We recall that incoming ECB head Christine Lagarde has already emphasized that onus of supporting growth cannot be completely borne by monetary policy and fiscal stimulus is also needed.
Financial markets, particularly the EUR/USD, were choppy during the announcements and after the press conference, as markets digested the impact of the announcements. While the ECB delivered on its promises, markets are unlikely to perceive this as enough to materially boost growth and inflation prospects. This backs our DBS FX Strategist’s view that growth and rate differentials favour the US vs Eurozone, which will reflect in the respective currencies. This is likely to keep EUR/USD in the lower 1.05-1.10 range this year.
EUR/USD FX Outlook
The US Fed cut expectations have stymied the European Central Bank’s stimulus bazooka to push the euro below 1.10 in the short-term. ECB President Mario Draghi delivered an asset purchase programme at his final governing council meeting on September 12. The APP will restart on November 1, when Christine Lagarde takes the reins at the ECB from Mario Draghi, at a pace of EUR20bn per month and end shortly before the ECB starts raising rates. The ECB’s forward guidance for rates to stay lower for longer is likely to be extended beyond its mid-2020 guidance based on the downward revisions in its growth/inflation forecasts.
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