The July ECB meeting aims at preparing the market for further easing in September. As expected, the members hinted that interest rate could fall to lower level. They also discussed about the possibility of restarting QE and the two-tiered interest rate system. The announcement was not without surprise. The explicit inflation target was removed and the bar for further easing was lowered. Yet, these surprises do not alter our view that a easing package would be announced in September.
Removing Explicit Inflation Target
ECB expects the policy rates to “remain at their present or lower levels at least through the first half of 2020”. Addition of “lower levels” came in as expected. However, reference to inflation target was tweaked to “and in any case for as long as necessary to ensure the continued sustained convergence of inflation to our aim over the medium term”. This was compared with June’s language that “… sustained convergence of inflation to levels that are below, but close to, 2% over the medium term”. The change might signal upcoming change in ECB’s interpretation in price stability. As suggested in the policy statement was that the members are “determined to act” if “the medium-term inflation outlook continues to fall short of our aim… in line with its commitment to symmetry in the inflation aim”. At the press conference, President Draghi affirmed that “commitment to symmetry around the inflation aim” and added that “which in a sense is 1.9%”.
Lowering Bar for Further Easing
As mentioned above, ECB noted that it stands ready to act if “the medium-term inflation outlook continues to fall short of its aim”. At the Sintra forum, Draghi suggested actions would be taken “in the absence of improvements”. We interpret this as easing would still come even if there is no downward revision on the updated economic projection in September.
Hinting Easing Package without Details
As mentioned in the statement, ECB “underlined the need for a highly accommodative stance of monetary policy for a prolonged period of time”. It also suggested that the relevant Committees would examine options, “including ways to reinforce its forward guidance on policy rates, mitigating measures, such as the design of a tiered system for reserve remuneration, and options for the size and composition of potential new net asset purchases”. These references indicate that the upcoming easing measure would be a package, rather than just rate cut. For the first time, ECB referred to “a tiered system” when it talked about “mitigating measures”. This evidences that the members are concerned about defending bank profitability as the deposit rate falls deeper to the negative territory. This has further increased the likelihood that the rate cut in September would come with a “two-tiered system”.
We reiterate our expectations that, in September, ECB would announce an easing package, including forward guidance enhancement, rate cut with tiering system and QE. ECB would cut the deposit rate by -20 bps from the current -0.4%, along with a tiering system. It could as the same time announce resumption of QE for 12 months initially, with corporate bonds and sovereign debt included the purchase program.