ECB Preview: Re-Opening the Door to Rate Cuts – Danske Bank
Senior Analyst, Pernille Bomholdt Henneberg at Danske Bank, expects a
dovish tone from Draghi at the ECB meeting this week, but no new
measures.
Key Quotes
“Despite the
comprehensive package of easing, which was announced in March, the ECB
is still under pressure to ease again as inflation expectations remain
around a historically low level, while the effective euro has
strengthened following the easing from the ECB.
We believe
Draghi will re-open the door for additional rate cuts after stating at
the latest meeting in March that he did not anticipate more rate cuts.
Draghi is likely to do this by emphasising the ECB’s forward guidance
stating that policy rates are expected to ‘remain at present or lower
levels for an extended period of time’.
A renewed focus on
cutting policy rates should not be a big market surprise, as the ECB
minutes revealed that ‘the Governing Council would not rule out future
cuts in policy rates, as new shocks could change the outlook for
inflation’. Generally, market expectations ahead of this ECB meeting are
not very high, but looking further ahead additional rate cuts are
priced in with a probability around 50% in September.
On the FX
side, soft words from Draghi support our view that the ECB may see some
temporary relief from a weaker EUR/USD. Much less stretched short
positioning in the cross leaves room for relative rates to play a role
in the cross again in 1-3M and we see potential for ECB-Fed divergence
to see a short-lived return.
Further details about the TLTRO II
loans will also be in focus. In particular, more information about the
lending benchmark, which determines whether the lending rate will be
positive or negative, will attract attention. The potential size and
maturity of the TLTRO II loans are already known and banks are allowed
to take four times the amount taken on the TLTRO I.
The first
weekly QE data after the up-scale to EUR80bn in the monthly QE purchases
showed a clear increase in government bond purchases. The additional
purchases were achieved entirely through higher public sector purchases
and Draghi is likely to be asked whether this pattern will continue
going forward. The ECB minutes stated that liquidity in the covered bond
market was ‘currently rather reduced’, which could suggest the ECB
prefers public sector purchases.
Despite soft words from Draghi,
we expect the ECB to remain on hold over the coming months while it
waits to see the effect of its recent policy initiatives. The first
TLTRO II auction and the purchases of corporate bonds will not start
until June, which should keep the ECB sidelined for some time.
In
a longer term perspective, we expect the ECB to extend the QE purchases
beyond March 2017. This should follow as inflation in our view will not
pick-up sufficiently for the ECB to remain on hold. We do not expect
additional rate cuts, but a strong appreciation of the effective euro
could force the ECB to cut again.”