The ECB is preparing for delivery

After Draghi’s shift in Sintra, we still see the ECB rate cuts as a starter and a first step before the implementation of a broader policy package.

We expect the European Central Bank (ECB) to prepare markets for the delivery of fresh monetary stimulus following Mario Draghi’s unequivocal signal in Sintra. An adjustment to forward guidance is the most natural path for the ECB to take, by signalling that policy rates will remain at present levels “or lower”, paving the way for a 10 bp deposit rate cut in September, to -0.50%.

The ECB will likely note that so-called risk contingencies have been triggered in the sense that the data released over the past month have not been strong enough to qualify as an “improvement” in the outlook.

However, this baseline scenario is now consensus and nearly fully priced in. The risk is that the ECB does more, sooner, rather than less, later. One justification for bold action would be the threat of a de-anchoring of inflation expectations, and we would not be surprised if Draghi references the upcoming Survey of Professional Forecasters at next week’s meeting.

We see a non-trivial chance that the ECB cuts rates at its 25 July meeting – after all, there is little justification for waiting another month. Another risk is that the Governing Council sounds open to several rate cuts, downplaying the importance of the reversal rate (below which negative interest rate policy becomes contractionary) while implementing a deposit tiering system.

More important for markets will be the degree of the ECB’s openness to loosening the technical constraints on new asset purchases (via higher issuer limits), which may strengthen the case for the announcement of a QE2 programme in September.

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