How much ECB QE is needed? Go big, or go home!
We expect the ECB to strengthen its forward guidance by linking the future path of policy rates to a new asset purchase programme.
We estimate that a new QE2 programme worth at least EUR600bn would be needed for the ECB to close a 0.50% inflation gap. If anything, the decreasing marginal returns of QE and the risk of a de-anchoring of inflation expectations call for a more aggressive programme.
How much does the ECB need to ease? QE size matters, but so do other parameters including the duration of the programme. Our initial expectation was for QE2 to be set at EUR50bn per month over 12 months. A compromise could take the form of a smaller quantum of purchases for longer — say EUR30bn over 18 months, EUR25bn over two years, or even open-ended asset purchases linked to a state-contingent forward guidance. Either way, we expect the issuer limits to be raised from 33% to 50%.
We don’t think that the opposition of the most hawkish members of the Governing Council will prevent the ECB from launching QE2. The risk is that a compromise solution centres on rate cuts and deposit tiering when evidence suggests that the effects of such measures have diminished, if they are positive at all.
Potential surprises could include an expansion of the QE-eligible universe to new asset classes (senior bank debt or equities), or more radical changes to QE parameters (removing capital keys). The bar for such radical changes seems high, although we would rule out nothing in a more adverse scenario next year.