ECB preview: More wait and see Pernille Bomholdt Henneberg Anders Vestergård Fischer Christin Tuxen Senior Analyst Senior Analyst Senior Analyst perni@uk.danskebank.com afis@danskebank.dk tux@danskebank.dk +44 20 7410 8157 +45 45 14 69 96 +45 45 13 78 67 Important certifications and disclosures are contained from page 15 of this presentation. 19 October 2015 Investment Research
ECB preview: more wait and see We expect the ECB to keep its powder dry at the meeting on Thursday, but to retain a dovish tone and reiterate that it can adjust the size, duration and composition of the QE programme. From a market perspective, the meeting should not provide further clarity but is likely to be seen as an intermediate meeting ahead of the December meeting, when the ECB will release updated projections. Only one out of 43 analysts in a Bloomberg survey expects the ECB to step up its QE programme in October whereas 51% expect it in December. Very low market-based inflation expectations still put strong pressure on the ECB and we expect the door for more easing to be kept open, but we do not see Draghi signalling that further deposit rate cuts are on the table. The ECB is only a third into its QE purchases and a number of ECB members have recently repeated the message from the September meeting that it is too early to decide whether more easing is needed. The ECB is currently focusing on the lower cost of borrowing and better availability of credit from the monetary policy transmission. However, ECB members also see downside risk to inflation from the emerging market turmoil, the stronger euro and the lower oil price, but despite the latest weak German data, the impact is still judged to be uncertain. Deflation print in September should not be enough for ECB to ease again. Draghi said in September that we may see negative numbers of inflation in the coming months. The Governing Council tends to think that these are transitory effects, mostly due to oil price effects. See Flash comment: Back into deflation, but Draghi will wait for more inflation prints, 30 September 2015. We still expect the ECB to extend its QE purchases beyond September 2016, but do not think it will be announced before the December meeting. The ECB may stay on hold until Q1 16. We see three potential triggers for more easing from the ECB: 1) the growth outlook deteriorates, 2) the ECB lowers its headline inflation projection, and/or 3) the ECB lowers its core inflation forecast. In fixed income markets, a deposit rate cut is priced in with more than a 50% probability in our view, the ECB is more likely to extend or increase the monthly QE purchases. Hence, we see the pricing as too aggressive. In FX markets, we expect EUR/USD to be little changed with risks tilted to the upside, as the ECB fails to deliver fuel to expectations on ECB-Fed divergence for now. 2
ECB members not on brink of announcing further easing Mario Draghi, 11 Oct: We are satisfied with QE, as it has met and even surpassed our initial expectations. QE has had a favourable impact on the cost and availability of credit for firms and households. See interview. Vitor Constancio, 15 Oct: An obvious challenge in the coming months will be the divergence between the monetary policy stance in the US and other major advanced economies. See speech. Yves Mersch, 14 Oct: It is too early to judge whether the-se factors [decelerating growth in emerging markets, a stronger euro and the fall in oil and commodity prices] will cause lasting changes to the trajectory that the ECB expected inflation to follow More time is needed. See speech. Benoit Cæuré, 12 Oct: We have only executed, delivered, one third of the programme It is all feeding into the economy at a slow pace It s premature to discuss it [another QE programme]. But it s certainly our duty to be prepared to cope with all kind of contingencies. See interview. Sabine Lautenschläger, 9 Oct: We do not have enough information right now to fully understand the underlying trend It is really premature to talk about concrete measures in terms of broadening QE. See Bloomberg. Peter Praet, 8 Oct: The cyclical recovery is progressively taking hold It [pessimism] holds back a stronger recovery, as uncertainty about the future can feed back into weaker investment today. See speech. The ECB is only one third into the current QE programme Source: ECB, Danske Bank Markets 3
Easing reflected in lower cost and better availability of credit Draghi has recently expressed satisfaction with QE ECB focuses on the traditional transmission mechanism Eurosystem Bundesbank Banca d'italia ECB Banque de France Banco de España Boosts economic confidence Higher inflation expectations Liquidity Assets Bond holders Lower bond yields (higher asset prices) Lower yields More credit Weaker euro Cheaper credit and more accessible Higher exports Supports GDP growth Higher inflation pressure Draghi, 11 Oct: The volume of credit is expanding, also in the so-called stressed countries. The overall cost of lending by banks to the private sector has decreased by something like 80 basis points, and by much more for the stressed countries. See interview. Source: ECB, Danske Bank Markets 4
Still pressure from low market-based inflation expectations Medium-term inflation expectations far below 2% target ECB also looks at other measures of market expectations Source: Bloomberg, ECB, Danske Bank Markets 5
Survey-based inflation expectations released after ECB meeting ECB should know the updated SPF inflation expectations The upward trend in real rates has been reversed Source: Bloomberg, ECB, Danske Bank Markets 6
Unchanged effective euro will be a headwind to inflation The latest appreciation of the euro is a headwind to inflation and Draghi is likely to attempt to talk the euro down at the meeting in October by mentioning the divergence in monetary policy in the euro area and the US. Effective euro will become a headwind to inflation In December, when the ECB releases new inflation projections, it will have to take into account the fact that the euro has strengthened, implying the outlook for inflation should weaken. The ECB s macroeconomic projections are based on the technical assumption that bilateral exchange rates are unchanged over the projected horizon. Given the current level of the effective euro, this implies it will turn into a headwind to inflation in 2016. The ECB also makes technical assumptions about the oil price based on the path implied by futures markets. Currently, the oil price has a slightly larger drag on inflation than in the September projection. But regarding the low oil price, the main risk is of second round effects. In case of this, the ECB will, in our view, ease again but so far it seems to be too early for it to be able to judge these effects. Source: Bloomberg, ECB, Danske Bank Markets 7
Easing trigger #1: growth outlook deteriorates further Euro PMIs stay above 50 despite global growth weakness German data weakens due to disappointing foreign demand Source: German Statistical office, ISM, Markit PMI, Danske Bank Markets 8
Easing trigger #2: the ECB lowers headline inflation projections Dip back into deflation is not enough for further easing Inflation to rise sharply but mainly due to base effects Source: Bloomberg, ECB, Eurostat, Danske Bank Markets 9
Easing trigger #3: the ECB lowers its core inflation forecast ECB s core inflation forecast is high versus output gap Core inflation is indirectly affected by the oil price decline Source: Bloomberg, ECB, Eurostat, Danske Bank Markets 10
Instruments left in the toolbox we expect QE extension later 1. Verbal intervention Delivered at September meeting. 2. Change composition of monthly purchases ISIN limit lifted at September meeting. 3. Extend current programme beyond Sep 2016 Is most likely in 2016, possibly December 2015 4. Increase size of monthly purchases In our view, more is still needed. 5. Strengthen forward guidance on policy rates The ECB is still signalling it is at the lower bound. 6. Cut deposit rate further The ECB did not discuss this in September. QE can be adjusted in size, duration and composition Source: ECB, Danske Bank Markets 11
Draghi continues to reject possibility of deposit rate cut The ECB cut the deposit rate to -20bp in September 2014 and since then Draghi has been asked about further rate cuts three times each time he rejected the possibility. Technical adjustment took deposit rate to -20bp in Sep- 14 and is signalled to be the effective lower bound Sep 15 ECB meeting: Q: Is that also an option for you, or is it still valid that the interest rates have reached the effective lower bound? Draghi: The (second) question was not discussed. Actually, the answer to your second question was not discussed today. Apr 15 ECB meeting: Q: Going back, on the potential scarcity of bonds, would you ever consider lowering the deposit rate? Draghi: The answer to the first question is no. Sep 14 ECB meeting: Q: Is there a risk that this [cut] undermines a bit the reliability of your forward guidance and your communications on the policy outlook to the financial markets and to the public? Draghi: No there isn t such a risk, because we announced about the interest rates that they would be for all practical purposes at the lower bound, but technical adjustments could be possible, and that s what we did. And now we are at the lower bound, where technical adjustments are not going to be possible any longer. Source. ECB, Danske Bank Markets 12
Fixed income markets: markets have priced in a deposit cut A neutral Eonia is 5-6bp above the ECB deposit rate ECB-dated Eonia swaps are being priced at around -20bp, a depo cut would be required for this to be realised 80 Eonia - depo (bp) Excess liquidity, EURbn 800 0.30% 70 60 Eonia realised over ECB reserve maintenance period (RMP) over deposit rate and exess liquidity 700 600 0.25% 0.20% 0.15% 50 500 0.10% 40 30 20 Low at last liquidity boost Feb13 RMP: 6.3bp 400 300 200 0.05% 0.00% -0.05% -0.10% -0.15% Excessive depo cut pricing 10 0 2009 2010 2011 2012 2013 2014 2015 100 6.1 0-0.20% -0.25% Jun-14 Nov-14 May-15 Nov-15 May-16 Nov-16 Excess liquidity Eonia RMP - deposit rate Eonia MLF MRO Deposit ECB Eonia fwd Source: ECB, Danske Bank Markets 13
FX markets: EUR/USD to be little changed We expect EUR/USD to be little changed at the ECB meeting with risks tilted to the upside as the ECB fails to deliver fuel to expectations of ECB-Fed divergence for now. Medium-term factors supportive of EUR/USD A source of volatility in the cross is the possibility of a deposit-rate cut: while we think the ECB is a long way from going down this route, any hints that going lower on rates would be able to take EUR crosses substantially lower as this would induce a level shift in a money-market curve otherwise well-anchored by current policy. More broadly, our not-so-aggressive call on ECB easing (a mere extension of QE, possibly not until Q1) limits the EUR downside from euro-area monetary policy, and we see EUR/USD range-bound between 1.10 and 1.16 in the coming months with a slight move lower with this range likely as markets buy into a first Fed hike in Q1 next year. Crucially, as we see no sustained trend in relative monetary policy beyond Q1, we expect to eventually see a gradual move higher in EUR/USD towards the levels warranted by medium- to long-term fundamentals in 2016; we now see the pair at 1.20 in 12M, see FX Edge: Introducing the Danske G10 MEVA model, 1 October 2015. Source: Macrobond Financial, Danske Bank Markets 14
Disclosures This research report has been prepared by Danske Bank Markets, a division of Danske Bank A/S ( Danske Bank ). The authors of this research report are Pernille Bomholdt Henneberg, Senior Analyst, Anders Vestergård Fischer, Senior Analyst and Christin Tuxen, Senior Analyst. Analyst certification Each research analyst responsible for the content of this research report certifies that the views expressed in the research report accurately reflect the research analyst s personal view about the financial instruments and issuers covered by the research report. Each responsible research analyst further certifies that no part of the compensation of the research analyst was, is or will be, directly or indirectly, related to the specific recommendations expressed in the research report. Regulation Danske Bank is authorised and subject to regulation by the Danish Financial Supervisory Authority and is subject to the rules and regulation of the relevant regulators in all other jurisdictions where it conducts business. Danske Bank is subject to limited regulation by the Financial Conduct Authority and the Prudential Regulation Authority (UK). Details on the extent of the regulation by the Financial Conduct Authority and the Prudential Regulation Authority are available from Danske Bank on request. The research reports of Danske Bank are prepared in accordance with the Danish Society of Financial Analysts rules of ethics and the recommendations of the Danish Securities Dealers Association. Conflicts of interest Danske Bank has established procedures to prevent conflicts of interest and to ensure the provision of high-quality research based on research objectivity and independence. These procedures are documented in Danske Bank s research policies. Employees within Danske Bank s Research Departments have been instructed that any request that might impair the objectivity and independence of research shall be referred to Research Management and the Compliance Department. Danske Bank s Research Departments are organised independently from and do not report to other business areas within Danske Bank. Research analysts are remunerated in part based on the overall profitability of Danske Bank, which includes investment banking revenues, but do not receive bonuses or other remuneration linked to specific corporate finance or debt capital transactions. Financial models and/or methodology used in this research report Calculations and presentations in this research report are based on standard econometric tools and methodology as well as publicly available statistics for each individual security, issuer and/or country. Documentation can be obtained from the authors on request. Risk warning Major risks connected with recommendations or opinions in this research report, including as sensitivity analysis of relevant assumptions, are stated throughout the text. Date of first publication See the front page of this research report for the date of first publication. 15
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