There’s a pretty strong consensus in the markets that something will come out of the ECB monetary policy meeting tomorrow. The question that will move the markets is: what?
There are quite a few potential measures that the ECB could take, and they all have different implications.
Before going over the options on the table, there is something unique about this meeting that could sway the results. This is the last meeting to be chaired by Mario Draghi, before Christine Largarde takes over.
Generally, it would be expected for the outgoing President to keep policy in line so new leadership can have a “clean slate” to enact their policy. But there are many analysts pointing out that Draghi wants to put forward something significant for his last meeting, to hand over the European economy in the best setting possible as he sees it.
The major question is whether the bank will cut rates. And going over Draghi’s comments as far back as June, this seems to be the case. The argument for a rate cut has been as an “insurance” adjustment for the less positive (but still not a recession) economic data over the last few months. This would be in line with the Fed’s last action.
There seems to be little objection to a rate cut among the board members. Even from the more hawkish Germans!
It should be noted that there is also expectations of further action by the Fed, which meets next week, along with the BOJ and SNB. This might be an opportunity for the ECB to “get ahead” of other major banks that are also considering action.
The more controversial proposal would be to restart buying bonds to support the economy.
Draghi has shown he is publicly in favor of this option, and the ECB has commissioned a study to explore how much and when to buy. Many analysts are in agreement that some kind of bond purchasing program will be announced, with the amount projected between €20-40B.
The problem is the hawkish members of the board are opposed to this kind of measure This is especially tr7ue for German, Austrian and Finnish members. Part of the problem is that the ECB has largely bought up all of the available bonds according to their current rules.
Cutting the Deposit Rate
This is a more technical measure and refers to how much banks have to pay to keep their money in the ECB. A “cut” here would raise the cost of keeping reserves in the ECB’s vault, in theory incentivizing banks to loan out more.
Since 2016, European banks have been keeping 13 times as much money in reserves than is required.
Banks argue that this is because of a lack of profitability due to the low interest rates. This measure also has considerably more consensus than the asset purchases. An argument for it is that by cutting the deposit rate by at least 20 points, it will maintain the interest spread and keep from encouraging banks to deposit more funds and diluting the effect of the rate policy.
A Bold Move
The consensus is that the ECB will issue a “package” of measures; with several policies designed to amplify each other and have a bigger effect on the market.
But many central bank trackers are expressing concern that the market might be getting ahead of the facts, and that the ECB won’t take as drastic action as is being priced in. That would expose upside risk for the euro if the central bank under-delivers.
Several Board members have already expressed concern about the long term effects of continued easing policy. The worry now is that the ECB has fallen into a liquidity trap similar to Japan; an argument that would be in favor of more asset purchases and not cutting the interest rate. However, that is not a view shared by a majority.
Bond yields and the currency show that the market is pricing in significant action from the ECB, in line with the consensus view. This would likely include a rate cut plus additional measures. The “surprise” to the downside for the markets would likely be an announcement of a significant amount of asset purchases since that has the least agreement.