ECB preview – so close, yet so far away
The European Central Bank’s meeting on 6 June is unlikely to result in major policy changes, but instead will focus on risk assessment and TLTRO-III. The press conference could set the stage for a policy response should downside risks materialise.
Long story short, the ECB should continue to err on the side of caution, while preparing for dovish contingencies, which could range from the easy to the scary. The easy plan would follow if risks to the outlook remain firmly tilted to the downside. The tricky would involve TLTRO-III being priced at a negative rate with conditionality, possibly at -20 basis points as a compromise to the hawks. And finally, the scary, with inflation expectations are one shock away from dis-anchoring, forcing a bolder policy response (quantitative easing).
While it is probably too early for the ECB to discuss monetary easing more explicitly, a new signal from Mario Draghi cannot be ruled out and could take several forms. At a minimum, the ECB should stand ready to use all policy instruments, if needed, not ruling out rate cuts or new asset purchases. Tiering, while seemingly ruled out in the near term, could make it to the policy toolbox in the event of low(er) policy rates going into 2020. Still, the market might not give the ECB the benefit of the doubt to use “all policy instruments” until the well-known obstacles to easing (issuer limits for quantitative easing; reversal rate for deposit rate cuts) are addressed explicitly.
Until now, our call has been that the ECB would deliver the first depo hike in March 2020 (from -0.4% to -0.25%), followed by a hike of 25 basis points in both the deposit and the refi rate in September 2020, bringing both rates to 0.0% and 0.25%, respectively. However, we have emphasised many times that our call was subject to significant risk, in the sense that rate hikes might start later. Considering the escalation in US-China trade tensions, a potential “insurance” rate cut by the Federal Reserve (in December 2019 and March 2020), which we did not foresee and the renewed signs of inflation expectations de-anchoring, we believe that a new ECB president (whoever it may be), would not be in a position to hike rates by March 2020 or later in 2020. As a result, we now rule out any rate hike by the ECB in 2020. That said, should the Fed stay on hold, a window of opportunity could be open for the ECB to rise rates at the end of 2020.