The European Central Bank's (ECB) macro-economic assessment has become grimmer. In particular, the ECB’s view on growth looks much more pessimistic than three months ago. In its latest projections, ECB staff now expects gross domestic product (GDP) growth to come in at 1.0% in 2015 and 1.5% in 2016. Back in September, this was still 1.6% and 1.9%, respectively.
The revisions to the 2015 forecasts are probably the sharpest ever downward revisions within one quarter. Interestingly, the narrative behind these growth forecasts has not changed. The ECB still believes in a modest economic recovery on the back of domestic demand and the global recovery. Risks, however, remain to the downside.
As regards to inflation, the ECB sounded more alarmed. The fact that staff projections had been revised downwards seems to be the main cause for the following quantitative easing (QE)-signals. ECB staff now expects inflation to come in at 0.7% in 2015 and 1.3% in 2016, from 1.1% and 1.5%, respectively, in the September forecasts. These revisions reflect mainly lower oil prices in euro terms and the impact of the downwardly revised outlook for growth.
During the press conference, Draghi repeatedly used the lower inflation forecasts and the fact that energy prices had dropped further in the last two weeks as the main reason for concerns. In our view, the importance of oil prices in the ECB’s current monetary policy discussion are a bit unclear.
In earlier times, the ECB would have tended to ignore short-term effects from oil-price fluctuations on headline inflation. Now, it seems as if Draghi is using oil as an argument to convince the last QE-opponents. However, it is remarkable that Draghi was relatively muted on the positive impact from lower energy prices on oil. Earlier this week, for example, IMF chief Christine Lagarde had said that the current drop in oil prices could add 0.8% on growth in most advanced economies.
The scene is clearly set for QE. Draghi’s comments during the Q&A could hardly leave any doubt: the ECB is determined to start some kind of QE in 2015.
Here are the key sentences: According to Draghi, the ECB will “reassess the monetary stimulus achieved, the expansion of the balance sheet and the outlook for price developments. We will also evaluate the broader impact of recent oil-price developments on medium-term inflation trends in the euro-area. Should it become necessary to further address risks of too prolonged a period of low inflation, the Governing Council remains unanimous in its commitment to using additional unconventional instruments within its mandate. This would imply altering early next year the size, pace and composition of our measures.”
Moreover, the slight change in tone that the ECB now “intended” and no longer “expected” the current measures to reach the size of the balance sheet from 2012 was the last evidence of the ECB’s determination.
So, where does all of this leave us now? Here are the facts: The ECB will discuss QE in the first quarter of next year. In our view, this will not yet take place in January as too little new information will be available by then.
As regards to the balance sheet, we will get the second Targeted Long Term Refinancing Operation (TLTRO) on December 11. Then, the run-off of the two earlier three-year LTROs (accounting for roughly €280 billion) could in the short run even reduce excess liquidity in the Eurozone.
Moreover, the March TLTRO will be the first one where the take-up depends on net lending and not the loan stock. Add to this the next staff projections and the ECB should have all information needed to go all the way. This makes us comfortable maintaining our current forecast of (an announcement of) a first intermediate QE in the first quarter, followed by sovereign QE in the second quarter, unless the eurozone economy stages an unexpected growth revival.
Obviously, not all ECB members, not even all members of the ECB’s Executive Board, are fully supportive on the role of the balance sheet in the ECB’s decision-making. However, the continued emphasis of low inflation will make it very hard for even the purest Germanic monetarists to eventually block QE.