Next Thursday the market is expecting the ECB to deliver a comprehensive easing package that will also include a new Quantitative Easing programme.
Investors are now more convinced that the ECB will deliver an attractive package after a collapse in exports pushed Europe’s largest economy to the brink of recession in the second quarter.
In a sign that an increasingly hostile trade war between the US and China is at least partially to blame for Germany’s deepening manufacturing malaise, shipments abroad declined 1.3%, causing a contraction in total economic output (the second over the past year). The Bundesbank predicts GDP could decline again in the third quarter.
Now the ball in the the ECB’s court. Below are some questions on what we expect from the ECB in its policy meeting next Thursday.
How large is the Quantitative Easing package expected to be?
We expect the ECB to announce a QE package of €45bn a month over a time frame of 15 months, starting in October. This would imply an injection into the European Economies of €675bn.
What will the ECB be buying?
70% of the purchases would be sovereign bonds €31.5bn a month or €472.5bn overall. The remaining 30% of the purchases would comprise Asset Backed Securities, covered bonds, corporate bonds and supranationals.
Will issuer limits be changed?
Given the size of the new QE programme the ECB is not required to change the issue/issuer limits. Hence, we believe the ECB will not change the rules at this stage – the argument for increasing the limit would hold if the ECB decides to increase the size of the QE program in the following months if economic data continues to deteriorate.
However, the ECB might also refrain from changing issue/issuer limits mindful of the decision of the German constitutional court, which is expected for the coming months.
Is the ECB expected to cut the deposit rate?
The ECB is expected to cut the deposit rate by 20 basis points to -0.6%. The rate defines the interest banks receive for depositing money with the central bank overnight.
What about the main refinancing rate?
The main refinancing rate is the rate at which the ECB lends to commercial banks and determines the cost of credit in the economy, remained unchanged at 0%.
What about the marginal lending rate?
The marginal lending facility is the emergency overnight borrowing rate for banks. This is expected to remain unchanged at 0.25 percent.
Will the ECB try to devise a tiering system?
The market expects the ECB to combine the rate cut with the introduction of a tiered deposit rate, to shelter the banking sector from some of the additional burden of lower rates.
What about guidance?
According to the ECB's current forward guidance, the Governing Council expects ECB key interest rates “to remain at their present or lower levels at least through the first half of 2020, and, in any case, for as long as necessary to ensure the continued sustained convergence of inflation to its aim over the medium term”. We expect this formulation to change materially with the introduction of a new QE programme.
In line with the practice during the last QE programme, the ECB is likely to affirm that interest rates are expected to stay at current or lower levels “until well past the horizon of the net asset purchases”; this is the minimum change we would expect for 12 September. This formulation would not only clarify the sequence of future policy normalisation – the termination of QE before rate hikes – but also help to flatten and anchor the EONIA forward curve well beyond the expected time horizon of QE.
However, the ECB might go further: its policy statement from 25 July makes it clear that the ECB is considering ways to “reinforce” its forward guidance.
This article was issued by Kristian Camenzuli, Investment Manager at Calamatta Cuschieri at Calamatta Cuschieri. For more information visit, www.cc.com.mt . The information, view and opinions provided in this article are being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice.