ECB primed for action

Today’s eagerly awaited ECB Governing Council (GC) meeting looks set to be critical following a large number of strongly worded hints from senior GC members that a package of easing measures is due at the June meeting.

At May’s press conference, ECB President Mario Draghi stated that members were willing to act, but that they preferred to see June’s staff forecasts first.

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These are likely to confirm March’s picture of a slow recovery and inflation still undershooting the ECB’s target of ‘below, but close to 2%’ by the end of 2016, so this is unlikely to be a barrier to action.

Strong rhetoric: A subsequent barrage of ECB comments since last month’s meeting has been consistent with easier policy. ECB board member Yves Mersch has remarked that not one but a combination of measures should be expected and that talk of interest rate reductions should be taken in the context of lowering the entire rate ‘corridor’, a very strong clue that the deposit rate will be brought down into negative territory.

Options: The ECB has a variety of objectives here, though they are all related to some degree. These may be summarised as: i) to ease policy to meet its inflation target; ii) to prevent inflation expectations from being dislodged to the downside and increasing the risks of deflation; iii) to stem upward pressure on the euro; iv) to secure and preferably speed up the recovery, possibly by encouraging credit flows. We tend to the view that the GC will announce the following moves:

a) A 10bp reduction in all three key rates, taking the deposit rate to -0.10%, the refi rate to +0.15% and the marginal lending rate to +0.60%.

b) A targeted scheme (perhaps an LTRO) which incentivises bank lending to the corporate and household sectors.

c) The GC may also suspend the weekly money market drains which it offers to sterilise the liquidity from the Securities Markets Programme (its mothballed bond buying scheme).

Currency thought of the day: Watch out for euro bounce

The market is holding its breath to see what measures Mr. Draghi and the ECB governing council introduce today. With a rate cut almost assured, and expected, it is the other package of measures which will determine how the euro reacts today. With a wide range of measures available and no general consensus emerging as to how these measures will shape up, there is plenty of potential for significant market moves over the course of the day. With various possible outcomes, it is worth bearing in mind that the ECB’s track record with monetary policy since the crisis has been far from pro-active; it rarely catches the market off guard, regularly delays action, and has never overwhelmed analysts’ expectations in any way. It’s worth bearing this in mind as we wait for today’s announcement, as there is every chance based on past performance that the ECB could under-deliver or delay on the big policy action, which could give the euro a temporary boost, and send euro crosses sharply higher today.