ECB- No ideal solution

Gilles Möec (chief economist at AXA IM) |  In our view, the ECB’s narrative lacks consistency at the moment. Most of the members of the Governing Council who have expressed themselves called for more fiscal stimulus. This was evident again in Bank of Spain Governor De Cos’ speech last weekend. We agree with that. But if even central bankers now consider that the fiscal leg of economic policy should take the lead, while they also recognize that additional monetary stimulus can come with adverse effects – to the point that another deposit rate cut must be “mitigated” – then the question of whether the monetary push is going to be a net positive arises.

Still, the European Central Bank (ECB) needs to do “something” on Thursday, for two reasons. First, a “package” has been so heavily telegraphed over the last two months that their credibility would be at risk. Second, the deterioration in the data flow has been so obvious since June that the macroeconomic forecasts which are about to be released cannot but signal another drift in inflation relative to the ECB’s target. That the ECB’s tools are reaching the limits of their efficiency is one thing, but that the central bank would accept not to be seen as “at least trying” is another. A package is coming.

The basis of such package is likely to be another deposit rate cut. As often with the ECB efficiency and political acceptability criteria are mingled. In our view, even with tiering, a deposit rate cut is not going to spur the economy much, assuming it is even a net positive. But for the hawks it is a lesser evil than quantitative easing (QE) and its unsavoury proximity with deficit funding. So the deposit rate needs to fall. By 10 bps in our baseline, with some probability of a bigger decline to 20 bps (if QE is weak, the ECB may want to settle on a bigger move on conventional instruments).

Then comes “mitigation”. We have already expressed our doubts on the appropriateness of “tiering” but it is probably the natural slope right now. Buying bank bonds would make sense in our view, but the ECB’s preferred avenue to provide additional mitigation to banks may be an extra dollop of generosity on the incoming Targeted-Longer Term Refinancing Operation (TLTRO). Moving the dial on this instrument would also help create the impression of a “package”.

Bond buying is the thorniest issue. We do not completely exclude the possibility that QE is not resumed at all. It is now a tangible risk. But our baseline is still that the ECB will give us a “small QE”, i.e. a time-limited buying programme at a fairly low monthly pace , consistent with the current limits of QE, in clear, EUR25 to 30bn a month for 6 months, shared across corporate and sovereign bonds.