EC Draghi’s Day To Deliver

The much anticipated ECB meeting is at hand. Yesterday’s disappointing eurozone CPI figures only fanned the anticipation. Today the service PMI was softer than expected at 54.2, down from 54.6.  

What will Draghi do?  There are four moving parts.  

The first is the deposit rate, which currently stands at -20 bp. When first adopted in September 2014, that rate was said to have exhausted the scope for interest rate policy. Of course, we know factually it is not because other countries, like Switzerland and Sweden, have gone further. Negative interest rates are a new development, and no one knows how far they can go. Ironically a cut in the deposit rate now seems among the less contentious things that the ECB will likely do. At least a 10 bp cut is expected, and the market may be disappointed with less than 15 bp. There is some talk of a tiered system that links the bank’s deposits with the deposit rate.  

A second element is the duration of the program. It also does not appear particularly contentious.The September 2016 end-date was always soft and conditional on the proximity to the inflation target. The staff’s forecast for inflation appears to require more than a three-month extension. The market may be disappointed with less than a six-month extension.  

A third element is the pace of purchases. It is currently at 60 bln euros a month. Some acceleration from here is likely though it is more contentious. Most participants appear to expect a 15-20 bln euro increase. This would have the ECB buying more bonds over a longer period.  Under the current dimensions, the ECB would buy 540 bln euros of assets in the first nine months. Under the revisions, assuming 75 bln a month for the entire year, it would buy 900 bln euros of assets.  

The fourth dimension of ECB policy that can be changed is the assets it is buying. Currently, bonds yielding less than the deposit rate are not included in the asset purchases. The anticipation of ECB easing has seen more instruments trade below the minus 20 bp deposit rate.  This is a self-imposed rule that the ECB can suspend or modify.  It can also include more assets into the program. There have been suggestions of sub-sovereign (e.g. local and state) bonds. There has also been some talk of increasing the state-owned entities, including agencies. Moving too far from sovereign credits may also be controversial. It is harder to quantify what has been discounted here.