Markets

The ECB released a new package of stimulus measures. First, they lowered the deposit rate by 10 bps to -0.5%. The new forward guidance suggests unchanged, or lower, rates until the ECB sees the headline and underlying) inflation outlook robustly converge towards its 2% target. Previously, the central bank stated that rates would remain at current or lower levels at least through H1 2020. The specific timing element is now gone: lower for longer.

Second, the ECB will restart its asset purchase programme from November onwards at a pace of €20bn/month for as long as necessary with an end data shortly before the central bank starts raising interest rates (QE infinity?). The ECB President suggested that the central bank has sufficient headroom to buy bonds for quite a long time without running into current issue(r) limits. The reinvestment policy of bonds maturing from the current portfolio remains in place.

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Third, the ECB changed the modalities of the TLTRO’s announced earlier this year. The lowest rate banks can achieve is the average interest rate on the deposit rate prevailing over the life of the TLTRO. The bottom rate originally was the average deposit rate plus 10 bps. The maturity of the TLTRO’s will also be extended from 2 years to 3 years.

Finally, the ECB decided to introduce a two-tier system for reserve remuneration in which part of bank’s holdings of excess liquidity will be exempt from the negative deposit facility rate. Draghi added that there was broad agreement within the ECB apart from the restart of asset purchases (“clear majority”).

The initial market reaction was the classic play: buy equity, buy bonds and sell the euro. Moves were partially reversed during the press conference though. An early sign that markets believe that the ECB is played out? EUR/USD tested the 2019 low (1.0926), but a break lower didn’t occur. The pair currently trades again the 1.0975/85 area. The German yield curve flattens with daily changes ranging between +4 bps (2-yr) and -4 bps (30-yr). 10-yr yield spreads vs Germany narrow by up to 8 bps with Italy (-13 bps) outperforming. The US yield curve bull flattens with yields down 1.0 bp (2-yr) to 4 bps (30-yr). European stock markets rise by up to 0.5%.

The ECB President clarified the central bank’s decisions during the Q&A session. A highly accommodative policy is necessary for a prolonged period of time given the persistent presence of downside risks. The ECB stands ready to adjust all parameters if necessary.

New GDP forecasts faced downward revisions for this year (1.1% from 1.2%) and next year (1.2% from 1.4%) but remain unchanged for 2021 (1.4%). Downside risks arise from geopolitical uncertainty, the threat of protectionism and vulnerabilities in emerging markets.

Inflation is expected to pick-up over the medium term, but the passthrough takes longer than expected. Draghi noted that inflation expectations are at low levels. The ECB downgraded inflation forecasts for 2019 (1.2% from 1.3%), 2020 (1% from 1.4%) and 2021 (1.5% from 1.6%). Risks for the inflation outlook are now tilted to the downside because of lower energy prices and the weak growth environment. Draghi ended by shooting out to fiscal policy to step up reforms and stimulus and take the torch over from monetary policy in keeping the economic expansion going.

News Headlines

The Turkish central bank for the second consecutive meeting cut is 1-week repo rate by more than expected, to 16.50% from19.75%. The policy rate stood at 24.00% before the first rate cut in July. Easing of inflation this year and the prospect for more to come allowed Governor Morat Uysal to support the economic recovery. The Turkish lira strengthened after the policy announcement with EUR/TRY trading near 6.27 (from 6.35 before the decision).

US headline inflation eased in August to 0.1% M/M and 1.7% Y/Y (from 0.3% M/M and 1.8% Y/Y). Core inflation, excluding volatile food and energy prices unexpectedly rose from 2.2% Y/Y % to 2.4% Y/Y %, the highest level since July 2018. Healthcare costs, prices rises for airline tickets, recreation and US cars contributed to rise.

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