Ecb watch september 2015

ECB Watch

Group Economics Macro & Financial Markets Research Nick Kounis, +31 20 343 5616

The next stage of QE?

Kim Liu, Aline Schuiling

2 September 2015 • • • • •

The ECB will likely lower its inflation forecasts in September… …and we see a 40% chance that it will step up its QE programmes… …this would likely take the form of an increase in the monthly purchase volumes We look at two scenarios: a EUR 20bn monthly increase and a EUR 40bn one More QE would likely encompass Länder bonds, as well as additional utilities credits and sovereigns

Introduction The ECB’s Governing Council meets tomorrow following an eventful time in markets, where increasing worries about China’s economic outlook have hurt risk appetite and pushed down commodity prices. We assess how likely the ECB is to ease policy further, as well as what it would do.

Oil price and ECB’s June assumptions Brent oil USD/barrel

70 65 60

Slump in commodities and global risks

55

The starting point for the ECB’s discussion will be the updated

50

growth and inflation forecasts. In its previous June projections,

45

the ECB made a number of technical assumptions about interest rates, the EUR/USD and commodity prices. The most

40 Jan-15

Feb-15 Brent oil

significant change since then is that oil and other commodity

Apr-15

May-15

Jul-15

Sep-15

ECB proj. June 2015 (average for 2015)

prices have fallen sharply and are now well below the ECB’s assumption (see chart), while it may also see heightened risks

Source: Thomson Reuters Datastream, ECB

from China and other emerging markets.

Conflicting influences on growth outlook

ECB projections June 2015

As the eurozone is a net-consumer of oil and other

%

commodities, the drop in their prices will have a positive impact

2.5

on GDP growth. If these prices were to stay close to their current levels during the rest of this year instead of level assumed by the ECB, this would be a positive for economic

1.5

1.8

1.5

1.5

growth. On the other hand, the ECB may downgrade its

1.0

forecast for global growth, which could offset the positive

0.5

impulse from oil, and it may also judge that downside risks

2

1.9

2.0

0.3

0.0

have increased.

2015

2016 GDP

2017

Inflation

ECB to lower 2015 and 2016 inflation forecast Meanwhile, the ECB will almost certainly reduce its inflation forecasts to closer to zero this year and around 1.25% next

Source: ECB

year, so further below the ECBs price stability goal of 2%. The longer-term forecast for inflation in 2017 (of 1.8%, respectively)

Governing Council will get mixed messages

will probably remain largely unchanged, given a broadly

The Governing Council may take some comfort on the growth

unchanged growth outlook.

side. Commodity prices could cushion any impact of weaker global demand. In addition, business surveys have help up extremely well, with a number of indicators rising in August.

2

The next stage of QE? – 2 September 2015

Finally, there is some tentative evidence that core inflation has

ended in any case, we think that only increasing the monthly

bottomed out. This could be a signal that disinflationary

purchase size would represent a significant stimulus.

pressures are abating. On the other hand, the decline in commodity prices means that headline inflation will be further

Size of additional purchases

away from the ECB’s price stability goal for longer. This could

The ECB’s current QE programme totals EUR 60bn per month.

increase concerns that inflation expectations will become

The central bank could plausibly decide to increase that

dislodged. Indeed market measures of inflation expectations (such as the 5y5y inflation swap) have come down again over recent months. Furthermore, the ECB already saw downside risks to the economic outlook at its recent meetings, and recent developments may mean that these have intensified.

amount by another EUR 20bn per month or another 40bn per month. Below we look at what these two scenarios mean for the extra purchases by member state, as well as what securities the ECB would buy. Assuming the programme runs for another 13 months (up to September 2016), this would mean a total increase of the QE programme by EUR 260 bn

Eurozone inflation expectations dip with oil %

USD per barrel

2.20

120 110

2.00

and EUR 520bn, respectively. Countries which have a high contribution in the ECB capital key would obviously need to buy the largest amount of extra securities (see table).

100 90

1.80

80

Size of additional QE by country Country**

70

ECB

EUR 260bn

EUR 520bn

capital key

increase

increase

DE

26

67

134

FR

20

53

105

IT

18

46

91

SP

13

33

66

NL

6

15

30

BE

4

9

18

AT

3

7

15

PT

2

6

13

On balance, we think that the ECB will keep its policy

FI

2

5

9

unchanged at Thursday’s meeting, though it is a very close

IR

2

4

9

1.60

60 50

1.40 Jul 14

40 Oct 14

Jan 15

Eurozone 5y5y (lhs)

Apr 15

Jul 15

Brent oil price (rhs)

Source: Bloomberg

Rising risk of additional monetary easing

call. In any case, we think ECB President Draghi will step up the dovish rhetoric, opening the door for future action. We think

Sources: ECB, ABN AMRO Group Economics

that the chances of additional monetary easing already at this

* In EUR bn

week’s meeting is significant, at around 40%. Recent

** Selected countries only, may not add up to total increase

commentary by the ECB’s Chief Economist Peter Praet suggests he will be one of the proponents of further easing at

Scarcity issues for some member states

the Governing Council meeting.

However, this does not show the full picture. In previous publications we argued that when taking into account net

Increasing size of QE most likely option

supply effects compared to the size of each market, the

If the ECB does step up monetary easing, what will it do?

decline in outstanding government bonds would be most

Cutting its deposit rate further into negative territory is an option, though President Draghi has made it clear in the past that enhancing QE would be the most likely way to add stimulus. The ECB has two options. It could communicate that QE will be completely open-ended, dropping the reference to

significant for the core countries (Germany, Netherlands, Austria and Finland). Also Portuguese government bonds would be bought significantly. In the event of an increase, the scarcity impact in the government bond markets would only be

September 2016. Alternatively it could increase the size of the

exacerbated for these countries. They would therefore be more

monthly purchases, which could also involve adding more

likely to want to turn to other securities apart from government

securities to the list of eligible assets. We think the latter is

bonds to expand the QE programme.

more likely. Given that the current programme is virtually open-

3

The next stage of QE? – 2 September 2015

Two options for the ECB to increase its eligible list

Adding utility names to the eligible universe would mainly

So the ECB would likely need to expand its list of eligible

increase the scope for the national central banks of France,

assets as well as increasing purchases of government bonds.

Italy and Spain. However, these member states do not have

From a big picture perspective we identify two options for the ECB. The first option is to add more corporate utility names (defined as agencies in the ECB collateral list) to the eligible universe. The second option is to include regional government bonds.

significant pressures in terms of meeting their government bond targets, as the size of their existing sovereign programmes is relatively moderate compared to the size of the market. So they could potentially more easily meet increased QE targets by increasing the amount of sovereign bond purchases. At the margin though, more utility names could be helpful for the national central banks of Germany, Austria and

Based on the ECB database of bonds which can be used for

Portugal.

collateral purposes, we calculate that the universe of utility corporate bonds with a maturity between 2 to 30 years equates

Meanwhile, adding regional government bonds to the eligible

to EUR 287bn. Using the same list, we calculate that the

universe would alleviate constraints in particular for German

eligible universe of regional government debt with a maturity

bonds, as the outstanding bonds are skewed towards bonds

between 2 and 30 years totals around EUR 310bn. The graphs

(Länder) with a German origin.

below show the market composition of corporate utility bonds This means Germany could make up a significant part of any

and regional government bonds per country.

increased QE target via a combination of Länder bonds and utility names. For other countries with scarcity, such as the

Breakdown of corporate utilities bond market

Netherlands, Austria and Finland, this is less of a possibility.

%

This means more of the increase would need to come from

50

even bigger government bond purchase programmes relative to the size of the market for these countries.

40 30 20 10 0 FR

IT

ES DE AT PT NL BE

FI

IE

PL EE

Source: ECB, ABN AMRO Group Economics

Breakdown of regional government bonds %

80 60 40 20 0 DE

SP

IT

FR

BE

Source: ECB, ABN AMRO Group Economics

AT

FI

CZ

PO

4

The next stage of QE? – 2 September 2015

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