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Large majority of ECB favors extending QE beyond March - ECB sources
Reuters sources
There's a logical disconnect here. If they decide to buy less bonds after March, that is a tapering announcement.
Euro Projected to Weaken through European Central Bank Rate Meeting
For the Euro to move higher tapering the asset purchase programme must be mentioned at Thursday's ECB meeting but also keep an eye out for the abolition of the 'capital key.'
The Euro will probably weaken against the Dollar during the European Central Bank's (ECB) rate meeting on Thursday, December 8, say Morgan Stanley in a briefing to clients ahead of the event.
The bank’s base-case scenario is for the ECB to announce an extension to its programme of asset purchases by another 6 months beyond the March expiry.
They also see a change to the criteria by which they decide which bonds are eligible for purchase.
“Our economist's assumption is that the ECB will keep rates on hold at next week's meeting but add a 6m extension to its QE purchase programme,” says Morgan Stanley’s Sheena Shah.
Morgan Stanley conclude that EMU front-end rates need to be pushed down more than those in the US to weaken EURUSD. "Simply extending purchases by 6 months would have limited impact on the EUR."
Analysts expect EURUSD to fall based on the rate differential staying wide and ensuring a continuation of broad USD strength.
US yields continue on their upward trajectory as a result of a more inflationary outlook due to President-Elect Trump’s expected stimulus package, whilst rates in the Eurozone have no such stimulatory driver to help them higher.
The Fed is also expected to raise interest rates in December, in comparison, the first-rate hike from the ECB is not expected until 2020.
“The first hike is now 38 months away in 2020 instead of 60 months away as was priced at the end of October,” says Shah.
In a currency pair money tends to flow to the currency with the higher interest rates as international investors seek higher returns on their cash.
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Morgan Stanley's potential scenarios & EUR/USD response for trading the ECB meeting
e believe the reaction of the EUR over the ECB meeting will ultimately depend on the probability of tapering in the next 12m. In particular, EURUSD will depend on the short end rate differential between EMU and the US. Our economist's assumption is that the ECB will keep rates on hold at next week's meeting but add a 6m extension to its QE purchase programme.
What is the market expecting?
Rates - no cut is priced for the December meeting and only 3.5bp by the end of 2017. The first hike is now 38 months away in 2020 instead of 60 months away as was priced at the end of October.
QE - the level of a bond yield is unable to give us an accurate measure of what the market is "pricing" in terms of further government bond purchases. Our only estimate is via speaking to our clients. Recent discussions suggest the majority of macro investors are not assuming the ECB will taper in 2017, indicating another extension would come in September.
Potential Scenarios and EUR response
1) Extends QE purchases for 6 months beyond March at current pace of 80bn/month. Expected by many market participants, already hinted at by ECB members speaking to MNI news, wouldn't be surprising for markets. Limited EURUSD impact. To extend purchases and leave an expectation in the market that they could extend again, the ECB would need to make some tweaks to its current programme that limits the scope for purchases. Here are some tweaks that the ECB could make and the potential EUR impact.
-a) No longer using the capital key to allocate purchases. As this approach could be bearish for the German bund but bullish for the periphery, we think the EUR could react positively. Note that the ECB doesn't necessarily need to explicitly express it is moving away from the capital key, they could indicate that they plan to be more flexible, in which case the EUR reaction should be limited. The market impact would be more volatile if they are explicit.
--b) Buy bonds below the deposit rate. Would generally be bearish for the EUR on the day given that this measure should put downward pressure on front-end German yields in particular.
---c) Change the maximum limit on buying per issuer/ISIN. This approach would generally be bullish for the whole German bund curve. For EURUSD to fall we would need to see a larger decline in bund yields than US treasury yields, pushing down the yield differential. EURUSD is generally more sensitive to front end rates (2y) than long end rates (10y).
----d) Scarcity to be addressed (Bundesbank repo facilities enhanced) We have to assume that the ECB will either discuss or be asked about scarcity of bonds, specifically in relation to short end bonds being used for repo purposes. Any rise in short end rates as a result of reduced worries about bond availability would strengthen the EUR but we wouldn't expect more than a 1% rise.
3) Extends QE purchases by more than 6 months. This would be unusual for the ECB to extend for more than 6 months as they haven't done that before so this measure would surprise markets. We would expect EURUSD to weaken.
4) No change in policy. EUR would rise as markets are expecting some form of easing. The magnitude of the rise will depend on the explanation given by the ECB and how it intends to scale back QE purchases. This would see German yields rise substantially, while Italian spreads likely widen out, pulling the EUR in opposite direction.
5) Extend corporate bond purchases but not government bond. 10% of the current monthly purchases are in corporate bonds. Extending this sector and not government bonds would imply a tapering of bond purchases. This scenario is highly unlikely and would be the most bullish of the scenarios considered here.
source
EUR: This Week's ECB Meeting Holds 2 Questions
For markets, this week's ECB holds two questions.
First, will there be a formal taper decision. Second, if there is no formal announcement to this effect (our base case is for a continuation of the bond buying program at an unchanged pace through late 2017), is the backdrop to the Governing Council sufficiently caustic that President Draghi in the press conference essentially signals that a taper will soon be coming. We think markets will treat either outcome with little distinction. EUR/$ would go up, perhaps substantially.
Some have been discussing scenarios that aim to split the difference for the ECB, for example tapering purchases to a monthly pace of EUR 40-50 bn, but then extending the program for longer, say through Q1 2018. We think such proposals fail to take account of how skeptical markets have become where the ECB is concerned. After all, the December 2015 meeting and the misfire in March of this year have taught markets to be extremely skeptical as to the ECB's willingness and ability to ease.
As a result, we think markets will put more weight on the tapering signal, rather than any kind of program extension (which is subject to modification anyway).
We think this is no time to taper, simply because of the challenging inflation dynamics in the Euro zone, in line with our European economics team's assessment A premature taper, which a decision to this effect at this meeting would certainly be, will only complicate the ECB's task of getting the Euro zone out of lowflation and fundamentally banishing deflation risk.
source
The focus will be on the ECB Thursday - here's a preview (& EUR/USD view)
ANZ Research (Brian Martin) on the European Central Bank meeting today (Europe time)
Courtesy of MNI here's the thoughts of some leading banks 8 Dec
ECB Interest Rate Decision: Rates On Hold, Bond Purchases Will Drop To EUR60 Billion From April 2017
Following the Council’s latest meeting, the ECB announced that asset purchases will continue at the current EUR80bn pace until March 2017. The Council also stated that asset purchases will then continue at a reduced pace of EUR60bn from April 2017 until December 2017.
The programme will be extended beyond December 2017 if necessary and, in any case until the ECB sees a sustained upturn in inflation consistent with its inflation aim.
In the meantime, the council will adjust the programme higher again or the duration extended if the outlook becomes less favourable again.
Markets had been expecting that the ECB would continue bond purchases at the EUR80bn rate until the end of 2017.
The main interest rates were left unchanged. The deposit rate was held at -0.40% with the main refinancing rate at 0.0% and marginal lending facility at 0.25%. Rates have been unchanged since the March 2016 meeting and there were no expectations that rates would be amended at this meeting.
The ECB also announced that it will change the parameters of some of the asset purchases and these technical changes will be communicated in the press conference. The measures will be announced to alleviate the shortages of bonds available to buy.
The Euro spiked higher following the decision with highs above 1.0850, but gains were pared quickly with a move back to the 1.0800 area. There was a sharp slide in bunds of over a point on the day, while the DAX index dipped sharply lower before paring losses and moving above pre-announcement levels.
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Dec ECB: QE Extension Supportive For Risky Assets And Somewhat Negative For EUR
At today’s meeting the ECB announced an extension of its QE program from March 2017 to the end of 2017. Against expectations, the rate of monthly purchases was scaled back from EUR 80bn to 60bn per month from April next year. If the outlook becomes less favorable and/or financial conditions tighten too much, the ECB will be prepared to increase the program in terms of size and/or duration.
With the announcement, the ECB has assured financial markets that monetary policy will remain accommodative throughout next year, but have at the same time carefully prepared markets for a future retreat from monetary stimulus.
The extended program will be supportive for risky assets and somewhat negative for the euro. Also, it does not change our view that yield curves will steepen with long yields rising in 2017.
Six French banks to sue the ECB to reduce capital demands
Reuters noting that BNPP, SocGen and Credit Agricole are part of a six bank team suing the ECB over their objection to capital demands against state banks.
They are after an exemption from having to hold capital against deposits sitting in a state owned fund, Caisse des Depots et Consignations.
The banks are taking their case to the European Court of Justice.
The banks have been squeezed on regulations and capital buffers after the crisis but it looks like they are now fighting back.
Full story from Reuters here.
ECB Economic Bulletin: Property Sector Will Have Key Inflation Role
Inflation trends will continue to be a very important influence on ECB policies during 2017 and will also be a key market focus over the next few months.
In the latest Economic Bulletin, the ECB still expects that inflation will rise significantly in the first quarter of 2017 due to the base effects of falling prices in early 2016. The key issue for the central bank will be whether there is a broad-based increase in inflationary pressure during the year ahead.
There is an analysis of housing costs and rents, which will be one of the key components of services-sector inflation trends and wider inflation developments.
Although there has been renewed upward pressure on property prices with a year-on-year increase of 2.9% during the first half of 2016, there has also been a further slowdown in the rate of rental inflation to around 1.0%, which is below the long-term average of 1.7%. According to the ECB, there has been some suggestion that the very low level of interest rates has lessened demands for higher rents to boost property yields and this has also been an important factor in holding back any reported increase in inflation.
The very loose ECB monetary policies will tend to put upward pressure on property prices during 2017 and any acceleration in rental costs would also tend to put upward pressure on wider inflation trends. If the increase in rental costs remains subdued, however, underlying inflation trends will remain weak, lessening the potential for a meaningful tightening of monetary policy.
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