ECB president Draghi opens the door for more easing – We Expect Another Dose of QE
It appears the multitude of uncertainties are starting to catch-up with the European Central Bank (ECB). The ongoing US-China trade war, pressure on the market-based/multi-lateral global economic system, noted by Mr. Draghi) and cyclical slowdown are all combining to make the case for additional central bank action , as inflation remains on a downward trajectory.
We have long held the view that the ECB will not be able to hike in this cycle and today’s extension of forward guidance to mid-2020 is another indication that rates are likely to remain low for the foreseeable future. There was also talk of additional quantitative easing (QE) within the governing council, and ECB president Mario Draghi noted a moderate-size QE program remains practically possible. All in all, we think Mr. Draghi would prefer to see additional easing before he steps down in October, and policy slate for the new chair is already getting constrained as forward guidance has been extended further. The details of another dose of Targeted longer-term refinancing operations (TLTROs) were also announced with quite generous terms and the risk of a funding squeeze for the banking sector has been rightly averted.
The trade war has been ramping up and the associated shock to confidence has led to a sustained contraction in global capex, alongside falling inflationary expectations. Consequently, we believe that the likelihood of another dose of QE that is focused on the corporate credit segment has risen and we think a policy announcement before October is very possible, especially if Governor of the Bank of Finland Olli Rehn continues to gather pace as the key front-runner for the ECB chair slot. This implies downward pressure on European rates will remain high, whilst the euro will suffer against G4 currencies. The extent of the damage against the USD will partly depend on how quickly will the Federal Reserve move towards a sustained cutting cycle in coming months.