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Hope and hype

Azad Zangana The ECB may have disappointed markets with its latest policy measures but, says Azad Zangana, senior European economist and strategist at Schroders, investors should have paid more attention to the improving macro data

Markets were disappointed by the news that European Central Bank (ECB) policymakers had under-delivered against expectations for further monetary stimulus measures. The difficulty for ECB President Mario Draghi is that the outlook for the eurozone did not necessarily warrant further stimulus.

  • Recent activity indicators have continued to improve despite the weaker external environment and concerns about security. 
  • Low inflation has boosted the disposable income of households in real terms
  • The resumption of credit flows is boosting domestic demand, aided by low interest rates

So much hype and yet so much disappointment. European Central Bank (ECB) president Mario Draghi’s reputation for always over-delivering stimulus against market expectations is now over. After spending the last two months strongly suggesting a significant increase in monetary policy stimulus measures, this didn't come true.

Five policy changes were announced on 3 December:

  • The deposit rate has been cut from -0.20% to -0.30% although the main refinancing rate and marginal lending rates have been left unchanged (0.05% and 0.30% respectively).
  • Quantitative easing (QE) of €60bn (£43bn) per month is now to be extended until March 2017. It was previously due to end in September 2016.
  • The ECB will now reinvest the principle payments of maturing assets under QE, for as long as necessary.
  • Regional and local government debt has been added to the list of eligible assets for QE.
  • Main refinancing operations (MROs) and three-month long-term refinancing operations (LTROs) are to be used until at least the end of 2017.

Against the menu of policy changes announced, markets were expecting at least a 20 basis points cut in the deposit rate, along with at least €20bn added to the monthly QE purchases. Given the disappointment, the euro initially rose by about 2.2% against the US dollar, while European bourses fell sharply. Clearly Draghi needs to re-examine his communication strategy. Seeming to always better what the market was anticipating was bound to lead to unrealistic expectations eventually – and therefore to disappointment.

Compared with our own forecast, we were not expecting an increase in monthly purchases, but were expecting an extension – albeit only until the end of 2016. The further cut in the deposit rate was also not factored in to our forecast, but we do not expect it to have much of an impact on growth or inflation. The other measures are designed to reduce the risk of technical difficulties hampering the implementation and the withdrawal of QE.

The difficulty for Draghi in his push for further stimulus is the outlook for the eurozone did not necessarily warrant it. Recent activity indicators have continued to improve despite the weaker external environment and concerns about security. Low inflation has boosted the disposable income of households in real terms, while the resumption of credit flows is boosting domestic demand, aided by low interest rates.

“Investors caught out will have to learn to look more closely at data and not expect the ECB always to look to appease them.”

Also, the euro had depreciated sharply from around 1.14 against the US dollar since October to as high as 1.08 in the wake of the ECB announcement. The ECB’s decision not to increase the amount of monthly purchases leaves some powder dry in case additional stimulus is needed next year. The Bank is clearly concerned about the capacity for purchases, given the limited supply of eligible assets and its own purchase limits – hence the inclusion of regional and local debt as eligible assets.

Overall, the additional stimulus announced on 3 December may have a marginally positive impact on the outlook for the monetary union. Investors caught out will have to learn to look more closely at data and not expect the ECB always to look to appease them. We now look forward to the US Federal Reserve’s policy decision. Assuming Janet Yellen follows through this time and raises interest rates as expected, we could see the euro resume its recent depreciating trend.

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