ECB Cuts Rates, Restarts Open-Ended QE, Announces Tiering, Enhances Forward Guidance

It was probably a stretch to suggest, as some did, that the September ECB meeting represented the most daunting challenge Mario Draghi has ever faced.

After all, every, single day is daunting when you’re tasked with holding together a fractious monetary union comprised of disparate economies harboring in some cases wildly divergent views on the correct course of fiscal policy and even on the desirability of preserving the euro itself. And that’s to say nothing of political differences across locales.

But even if Draghi has successfully scared away bigger demons, the current situation which finds the ECB confronting decelerating growth (nascent signs of stabilization in PMIs notwithstanding) and inflation that’s half of where it was a year ago, with rates already in negative territory and the balance sheet still bloated, is vexing.

Read our full ECB preview for the context

Draghi’s response: A cut to the policy rate of 10bps, the announcement of a tiering system to mitigate the impact of the plunge further into NIRP, a restart to QE at a pace of €20 billion/month, changes to the terms around the new TLTROs and, importantly, open-ended forward guidance that suggests rate hikes and a wind down to the newly re-activated asset purchases will be contingent upon inflation outcomes. To wit, from the statement:

The Governing Council now expects the key ECB interest rates to remain at their present or lower levels until it has seen the inflation outlook robustly converge to a level sufficiently close to, but below, 2% within its projection horizon, and such convergence has been consistently reflected in underlying inflation dynamics.

The Governing Council expects [asset purchases] to run for as long as necessary to reinforce the accommodative impact of its policy rates, and to end shortly before it starts raising the key ECB interest rates.

That effectively means the ECB is committed to buying bonds for as long as necessary to get inflation up to target. Christine Lagarde has indicated she will seek continuity when she takes the reins, so this would appear to mean that QE will persist indefinitely in Europe, subject to the issuer caps which are a self-imposed constraint (political considerations notwithstanding).

Additionally, note the “or lower” in the forward guidance on rates. That was expected, but it indicates that the ECB does not think the lower bound has been reached yet.

You can weigh all of that against consensus (right-hand column below) using the following table from Barclays.

(Barclays)

It will be hours before the market settles on a “definitive” interpretation of the decision (obviously Draghi’s presser will be parsed relentlessly), but for context, Goldman notes that the size of the rate cut will be perhaps the key determinant of the overall reaction. “One of the most important drivers of lower yields in Europe has been a re-appraisal of the lower bound [and] with the market pricing 14bp, there will be useful signaling value on the lower bound from the increment of cuts announced”, the bank said Wednesday. “If the ECB cuts 20bp and retains its easing bias, then the market’s dovish view of the ELB will be endorsed, and the support of future rate distributions will remain low”, Goldman went on to suggest, before cautioning that a 10bp cut would have made it “more difficult to sustain the trough pricing in the curve at -70bp or below”.

Headed into Thursday’s meeting, policymakers in Europe had been keen to downplay market expectations for a restart of ECB QE. Much of the pushback has come from arch hawks. Klaas Knot weighed in on August 29, for instance, days after Jens Weidmann chided that the ECB “shouldn’t act for action’s sake.” But then Sabine Lautenschlaeger got in on the act, as did Madis Muller. Even the outgoing Ewald Nowotny said central banks should be prepared to disappoint markets when expectations run too far out ahead of policy.

That said, the July statement clearly paved the way for the delivery of an easing package, it was just a question of what would be included.

“By our estimates, markets are expecting around EUR200-250bn of additional QE… largely in line with our expectations for a programme with a run rate of EUR30bn per month (EUR25bn in sovereigns) and lasting around nine months”, Goldman said going in, adding that “the capacity for dovish surprises on this dimension is limited”.

(Goldman)

“The ECB has, for several quarters, been insisting current weakness is a soft patch but, not only is the soft patch not improving, in our view, all indications are that it is likely to be a deterioration sharp enough to worsen the inflation outlook rather than merely postpone inflation’s rise to target”, BNP cautioned this week. “All this at a time when the market and commentators are increasingly questioning the ECB’s ability to achieve its inflation aim”, the bank chided, on the way to saying that in their view, “a timely response would demonstrate the Council’s determination to act”.

As noted above, growth has indeed decelerated.

And inflation is parked at just 1%, while inflation expectations have plummeted, endangering the central bank’s credibility as markets begin to buy into the “Japanification” story.

Draghi (and especially the hawkish ECB officials who came out over the past several weeks against more QE) has been careful to downplay the idea that deflation is imminent, but skeptics abound.

Below, find the statement.

Full statement

At today’s meeting the Governing Council of the ECB took the following monetary policy decisions:

(1) The interest rate on the deposit facility will be decreased by 10 basis points to -0.50%. The interest rate on the main refinancing operations and the rate on the marginal lending facility will remain unchanged at their current levels of 0.00% and 0.25% respectively. The Governing Council now expects the key ECB interest rates to remain at their present or lower levels until it has seen the inflation outlook robustly converge to a level sufficiently close to, but below, 2% within its projection horizon, and such convergence has been consistently reflected in underlying inflation dynamics.

(2) Net purchases will be restarted under the Governing Council’s asset purchase programme (APP) at a monthly pace of €20 billion as from 1 November. The Governing Council expects them to run for as long as necessary to reinforce the accommodative impact of its policy rates, and to end shortly before it starts raising the key ECB interest rates.

(3) Reinvestments of the principal payments from maturing securities purchased under the APP will continue, in full, for an extended period of time past the date when the Governing Council starts raising the key ECB interest rates, and in any case for as long as necessary to maintain favourable liquidity conditions and an ample degree of monetary accommodation.

(4) The modalities of the new series of quarterly targeted longer-term refinancing operations (TLTRO III) will be changed to preserve favourable bank lending conditions, ensure the smooth transmission of monetary policy and further support the accommodative stance of monetary policy. The interest rate in each operation will now be set at the level of the average rate applied in the Eurosystem’s main refinancing operations over the life of the respective TLTRO. For banks whose eligible net lending exceeds a benchmark, the rate applied in TLTRO III operations will be lower, and can be as low as the average interest rate on the deposit facility prevailing over the life of the operation. The maturity of the operations will be extended from two to three years.

(5) In order to support the bank-based transmission of monetary policy, a two-tier system for reserve remuneration will be introduced, in which part of banks’ holdings of excess liquidity will be exempt from the negative deposit facility rate.

Separate press releases with further details of the measures taken by the Governing Council will be published this afternoon at 15:30 CET.

The President of the ECB will comment on the considerations underlying these decisions at a press conference starting at 14:30 CET today.