All Eyes on ECB: Extension of QE, or just More Wait-and-See?
Fundamental Forecast for Euro: Neutral
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The European economy continues to flail, that much can be widely agreed upon without further debate. Unemployment throughout the bloc remains stubbornly above the 10% threshold, and this week, more evidence contributed to the mounting case that the March ‘bazooka’ of stimulus triggered by the ECB has yet to show any additional signs of promise for the European economy. Inflation numbers for the Euro-zone were released on Wednesday, and in what’s become a common occurrence, printed below expectations with a meager .2% print; furthering the concern that the recently unveiled package of measures may not be enough to move the economy towards the banks 2% inflation target.
This continued lack of growth and failure to produce inflation has led many economists to the expectation that the ECB might go for even more stimulus at their upcoming meeting on Wednesday-Thursday of next week; either through a deeper cut of the deposit rate into further negative territory (low probability, less likely after recent PMI’s), or perhaps through an extension of the bank’s €80 billion-per-month bond buying program beyond its currently designed March 2017 end-date.
And while an extension of the bond-buying program appears to be highly-likely ahead of March 2017, it may make more sense for Mr. Draghi and company to save such an announcement for later in the year in the event that extreme risk aversion begins to again show within the European economy. When Mr. Draghi last took the podium in July, we had the potential for such a situation with the recently-triggered Brexit referendum. There was a lot of uncertainty; nobody really knew what was going to happen, but the threat of an adverse event to an already fragile economy teetering with the hope that positive impacts from QE would begin to show; and there was a very real reason to be on guard. But, at least at this point, that risk appears to be contained as it doesn’t appear that we’re going to see Article 50 triggered anytime soon.
While it may seem more sensible for the ECB to continue to throw money after the problem of persistently-high unemployment and nearly non-existent inflation as they did in March, a larger debate has begun to rage about the efficacy of QE given the potential risk of longer-term side-effects. To be sure, markets haven’t seen the extreme negative aspect of those side-effects just yet, but that doesn’t mean that we’re out of the woods. The rate cut(s) into negative territory from the ECB have created absolute distortion in bond markets across Europe. Yields are abysmally low, prices are outrageously high, and to this day – we have struggling economies like Spain, Italy and Portugal yielding far less than comparable U.S. debt. And the past two years have shown how challenging it can be for a major economy to move from an ultra-dovish, QE-braced stance into a more normalized-environment; as the United States is still struggling to ‘normalize’ policy after the Fed’s concerted efforts to do so over the past 12+ months.
We’re starting to hear members of the ECB openly voice such concerns, as we heard from Benoit Coeure at the Jackson Hole Economic Symposium. As the most high-ranking ECB official attending last week’s events, Mr. Coeure warned of the potential side effects of over-use of ‘unconventional monetary policy’ for too long.
In terms of Neo-Keynesian economics, we’re treading in uncharted territory here. Before 2016 the ECB had displayed a pattern of relative prudence, often preluding a major announcement a meeting or two before it was actually announced. This happened ahead of both ‘major’ QE announcements out of the ECB in the past few years. In May of 2014, Mario Draghi mentioned that an announcement would likely be forthcoming in regards to QE. And after the bank did nothing in June, they delivered in July 2014 and this kick-started the 3,000+ pip run that drove the Euro to the current zone of support against the US Dollar. This happened again in November of 2015 ahead of the ECB’s December meeting. Disappointment reigned supreme when the bank moved lightly in December; but they came back in a very big way with a gargantuan plan that blew away even the most aggressive expectations in March.
Under this pattern, it would be highly unlikely to see the European Central Bank make any moves that may prove to be too provocative given that portions of the recently triggered package are still on their way to being filtered through the economy, and, frankly, the ECB may be nearing a dearth of ammunition, at least in the near-term. This may simply be a case where the bank sees the risks of any ‘big actions’ far outweighing the potential pay-offs.
So – do not expect any ‘big’ announcements from Mr. Draghi on Thursday. We may hear of an extension of the bond-buying program, but even that could (and perhaps, given range of options, should) be delayed until December. For the week ahead, we’re holding a neutral forecast on the Euro.
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