ECB Decision January 22, 2015

  • As expected the ECB launched sovereign QE at its policy meeting in order to bring inflation back  to target over the medium term, outperforming expectations regarding the size of the total asset purchase programme.
  • The TLTROs (targeted long-term refinancing operations) were made more attractive by removing the 10 bp spread vs. the rate on main refinancing operations (MRO).
  • Starting in March 2015, the ECB will carry out purchases of private and public assets of EUR 60 bn per month until September 2016 and “in any case until a sustained improvement in the path of inflation, consistent with the target” is achieved. Combined with the TLTROs, the additional purchases of ABS/CB (covered bonds) and sovereign bonds purchases would reach a total of about EUR 1.3 trillion by Sep 2016. This is above the EUR 1 trillion that was deemed necessary to go back to the size of ECB’s balance sheet in 2012 in December 2014. This is therefore an easing of the monetary policy stance beyond earlier market expectations, justified by the deterioration in the medium-term inflation outlook.
  • Furthermore, the expanded asset purchase programme has an open-ended feature, to the extent that the commitment to September 2016 could be extended conditional on inflation developments. The technical constraints of the sovereign bond purchase programme, which allow the ECB to be pari passu without blocking a restructuring and not to distort market prices, are unlikely to be binding at this stage (caps at 25% by issue and 33% by issuer).
  • Draghi strongly addressed the potential issue for bond markets of partial risk sharing (20% only of additional asset purchases will be subject to risk sharing in case of potential losses), suggesting that market focus and discussions on the subject were “futile”. He emphasised that the “singleness of monetary policy” was not being compromised, as the design of the programme by the ECB governing council was meant to ease broad monetary conditions across countries while national central banks were executing the programme. It seems that the ECB was able to surprise on the upside with the size of its expanded asset purchase programme by sharing risks on 80% of the assets only, thereby achieving a large majority on the decision to  launch QE as of March 2015.
  • Assuming the ABS/CB purchase programme continues at the same monthly pace (EUR 10-15 bn/month), sovereign bond purchases would reach about EUR 45-50 bn per month. The total sovereign QE programme would then reach EUR 855 to 950 bn at the very least (or up to 15% of bond market, 9-10% of GDP). This makes ECB’s sovereign QE a large programme even compared to the past sovereign QE programme in the US (17% of the bond market, 11% of GDP). In terms of absorbing all annual net issuance, the magnitude of the ECB programme can even be compared to that of the BoJ.
  • We expect ECB action to support a rebound in 5-year in 5-year inflation expectations (1.73% currently). The move in real interest rates between the EUR and USD should return as a bearish driver of the EUR/USD (see chart 1 and chart 2 for a more recent focus). Although next week’s FOMC statement may fail to provide a trigger, US cyclical dynamics, in particular the positive backdrop for consumption and labour market improvement, should be consistent with a rise in US nominal and real rates over the next few weeks.

 Chart 1: EUR/USD and 10-year real rate differentials likely to reconnect

EUR/USD and 10-year real rate differentials likely to reconnect

Source: Bloomberg, as of 22 Jan 2014.

Chart 2: Decline in real yield differential has further to go as ECB anchors inflation expectations

Decline in real yield differential has further to go as ECB anchors inflation expectations

Source: Bloomberg, as of 22 Jan 2014.

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