ECB: Draghi unveils a credible and dovish policy plan

LOcom_AuthorsAM-Arnaud.png   By Charles St Arnaud
Senior Investment Strategist


The European Central Bank has announced that it will reduce the pace of purchases in its Asset Purchase Programme (APP) from January 2018, while giving ample assurance to the market that it remains open to a rev-up in purchases should circumstances change.

News of the ECB’s plans to halve the monthly APP spend – from the current EUR 60 billion to EUR 30 billion – was accompanied by an announcement that it will extend the duration of the programme to September 2018 or beyond. The ECB also reiterated the flexibility of its policy saying that “the Governing Council stands ready to increase the APP in terms of size and/or duration” if needed. As for its broader monetary policy plans, the ECB continued to say that it expects interest rates to remain at current levels “well past the horizon of net asset purchases” and that it “will reinvest the principal payments from maturing securities purchased under the APP for an extended period of time” after the end of its net asset purchases.

While the announcement was broadly in line with economists’ expectations, the market has clearly viewed the announcement as dovish, as evidenced by a weaker Euro, lower yields, narrower spreads and higher equity prices. The very credible forward guidance provided by the ECB has dampened expectations in the market that strong Eurozone growth would force the ECB to act more quickly to remove its policy stimulus. We note that the ECB’s decision to provide strong forward guidance that monetary policy will be very accommodative for an extended period could in part be driven by a desire to avoid a further appreciation of the Euro, given its impact on inflation; something we have highlighted in the past.

Our view is unchanged following this latest ECB meeting in terms of how the monetary policy stimulus removal will evolve and take shape. As such, we believe that the ECB will end the APP program in late 2018 and keep reinvesting maturing bonds afterwards. In our view, the first rate hike will only happen once the APP program is over and is likely to take place in the first half of 2019, while the end of reinvestment (in other words, balance sheet reduction) is unlikely to happen until 2021. That said, the ECB remains flexible and the exact timing of any changes to monetary policy will remain dependent on the growth outlook, inflation and financial conditions.

Judging by the market’s reaction, the ECB seems to have achieved a skillful balancing act – pulling off a dovish tapering of monetary policy stimulus measures by outlining a credible forward path. And while it may not be long before continued economic strength causes the market to question whether a faster unwind of stimulus measures might be necessary, we believe the focus of the ECB remains firmly on inflation developments rather than growth – as long as inflation rates remain modest, we expect the ECB to stick to its current policy plan.

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