After weeks of speculation that interest rate cuts and another round of asset purchases are on their way, investors hope Thursday’s European Central Bank meeting will give the clearest signal yet of imminent policy easing, if not the details.
ECB chief Mario Draghi last month flagged fresh easing to fight stubbornly low inflation. Fellow policymakers have backed his call.
With a U.S./China trade war hurting euro zone exporters and the Federal Reserve expected to lower U.S. rates at its July 30-31 meeting, markets are betting on a September ECB rate cut.
Here are five key questions on the radar for this week’s ECB meeting:
1. What can we expect on Thursday?
Economists polled by Reuters expect the ECB to change its forward guidance toward easing this week, and cut the deposit rate in September.
“In response to weak growth and still subdued inflation, the ECB will likely adjust its guidance in July and vow to keep rates at “present or lower” rather than just at “present” levels,” said Berenberg economist Florian Hense.
Bond markets, also positioned for a September cut, will likely stage a tantrum if there is no such signal.
Germany’s 10-year bond yield this month briefly fell below the ECB’s depo rate for the first time, another sign that investors are betting on lower rates.
2 – So, a July rate cut is off the table?
Waiting until September to cut rates gives the ECB extra time to deliver a package of easing measures, say analysts. The latest ECB economic forecasts are also due that month and the bank tends to time big changes with these updates.
UBS expects the ECB to announce a 10 bps rate cut in September alongside a tiered deposit rate to alleviate the pressure of negative rates on banks.
But don’t rule out a July surprise. The ECB may want to pre-empt a Fed rate cut that pushes down the dollar and strengthens the euro — in turn hurting exporters and weighing on inflation.
Countering euro strength, rather than lowering rock-bottom borrowing costs, would be the main reason for a rate cut, one source told Reuters recently.
For others, recent dovish comments from ECB hawks point to a July move. Commerzbank expects a 20 bps ECB rate cut on Thursday to stay “ahead of the curve.”
3 – Is the ECB preparing for a return to QE?
Some banks certainly think so and are studying the tweaks to ECB rules needed to make way for new asset purchases.
After hovering up 2 trillion euros ($2.27 trillion) worth of public sector bonds since 2015, the ECB has neared its self-imposed ceiling of owning no more than a third of a country’s debt.
The ECB could circumvent the rule by stripping central banks of their voting rights in the event of a debt restructuring, a recent report suggested.
“They could say they are ready to increase the issuer limits, why not do it?,” said Pictet Wealth Management strategist Frederik Ducrozet. “That doesn’t require a lot of work.”
Speculation that ultra-easy policy will remain in place for some time could also be fueled if the ECB comments on recent talk that it is mulling tweaks to its near 2% inflation target.
Reuters Graphic
4 – Does Draghi have a view on Lagarde as next ECB chief?
Outgoing IMF head Christine Lagarde is set to replace Draghi when his term ends in October.
After critics said she lacked relevant experience, ECB officials such as Benoit Coeure have defended the nomination, calling her “uniquely qualified”.
Draghi will likely echo that view. He may also be asked whether a new package of easing just before he leaves will tie the hands of his successor.
For markets, the ECB’s dovish policy stance is set to continue under Lagarde, who has supported QE in the past. Her appointment was met with another bond market rally and a ratcheting up of rate-cut expectations.
Reuters Graphic
5 – Could the ECB beef up TLTRO 3?
The shift in the ECB’s policy stance has helped stabilize market inflation expectations but they remain very low.
The ECB could introduce more generous terms to its plan for more multi-year loans to help lift price and economic growth.
In its new targeted longer-term refinancing operation (TLTRO), unveiled in June and set to launch in September, the ECB will give banks credit at rates 10 bps above its minus 0.4% deposit rate – paying them to take its money.
Some policymakers argued in favor of making the new TLTRO terms more generous and more in line with previous packages, minutes from the June meeting showed.
“What we’ve seen in last two months is that global growth risks have risen and there is more uncertainty, that’s where the pressure to do more on the TLTROs comes from,” said James Rossiter, head of global macro strategy at TD Securities. – Reuters