ECB to recalibrate dovish expectations

ECB to lower deposit rates by 10bp to -0.50%, introduce a tiered deposit scheme, enhance LTROIII and signal upcoming asset purchases.
Radhika Rao, Philip Wee11 Sep 2019
    Photo credit: AFP Photo

    Eurozone: ECB to cement dovish path

    The European Central Bank Governing Council is likely to cement a dovish path until at least the end of 2020, when they meet on Thursday. Markets have bet heavily on aggressive policy support, reflected in the sharp decline in core and peripheral 10Y bond yields, 2Y yields slipping below the deposit facility rate (of -0.4%) and drop in EONIA rates. As the DBS Strategist noted last week, entire yield curve of highest-rated Germany and Netherlands is below zero, with lower-rated papers like Portugal also negative up to the 7Y tenor.

    We expect a mix of easing measures – dovish forward guidance, 10bp cut in the deposit facility rate (currently at -0.4%), introduction of a tiered deposit scheme to temper the impact of this cut, (which will turn) LTROIII on attractive terms and signal upcoming asset purchases. The decision to resume QE will not be easy as the Council remains split, with hawks – Germany, Netherlands, Austria and Estonia central banks and an executive board member - cautioning against turning hostage to market expectations.

    Markets have run ahead of themselves. Any sign that the ECB has fallen short of expectations might result in short-term unwinding in positions. Wary of the overwhelming burden on monetary policy, the incoming ECB chief Christine Lagarde has already called for fiscal policy to play a more proactive role, to support growth and reverse a decline in inflationary expectations. Besides a prolonged US-China trade dispute, EU leaders are also likely to monitor Brexit developments closely as the political tug of war escalates ahead of the October 31 deadline.

    FX: EUR to recalibrate with ECB expectations

    The euro has been hesitant to trade below 1.10 in September. Heightened expectations for ECB President Mario Draghi to announce a “big bazooka” stimulus during his final governing council meeting on September 12 have waned. The euro is also getting a brief respite from two external factors that have weighed heavily on the Eurozone economy. First, hard Brexit fears have dialled down with the shutdown of the UK parliament till October 14. Second, trade war rhetoric has cooled ahead of the China-US trade talks scheduled for early October. The euro’s correction (recovery) has been symptomatic of the fatigue that has set in for trade tensions, Brexit and the flight to safety into sovereign bonds.

    It is premature to call the bottom in the euro. Until British Prime Minister Boris Johnson has resigned or requested Brussels for another Brexit delay, the possibility of the UK exiting the EU without a deal on October 31 cannot be fully dismissed. Hopes for a de-escalation in trade tensions run counter to US’s intentions to take China to task on currency manipulation (at the trade talks) and the scheduled additional 5% US tariffs on USD550bn of Chinese goods on October 1. These are the two risks that will keep Mr Draghi dovish over the threat posed by the weak Eurozone outlook to the ECB’s price stability mandate. Resuming the asset purchase program will probably be left to Mr Draghi’s successor, former IMF Chief Christine Lagarde.


    Radhika Rao

    Economist – India, Thailand & Eurozone


    Philip Wee

    FX Strategist - G3 & Asia

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