In the last few minutes ECB officials have reportedly leaked that the ECB council will discuss a QE programme that is EUR 50 bn a month through to 2016, the equivalent of EUR 600 bn a year. Below, we look at the potential scenarios for ECB QE and the potential market impact.
On Thursday 22nd January, the ECB will announce its latest policy decision. The market is in full-blown QE mode, and after the Swiss dropped its EURCHF currency peg last week expectations are high that a QE package from the ECB is on its way.
Earlier this month, a leak from the ECB suggested that the Bank would announce a EUR 500 bn package, however, in the aftermath of the drastic actions from the Swiss National Bank (SNB) last week, the bulk of the market now expect a package at least EUR 500bn in size, with some market participants looking for the ECB to announce a EUR 1 trillion programme.
The ECB are notoriously hard to predict as Draghi presides over trying to please 19 member states. We believe that Draghi wouldn’t risk the market’s ire by not announcing QE at this week’s meeting, however, it’s the details of the programme that really matter. Below we lay out a few potential options that Mario Draghi may choose:
1) EUR 500bn QE package
This would disappoint the market. A EUR 500bn one-off QE package may be considered too paltry to make a difference, especially since the Bank of Japan has committed to do more than this each year until its CPI rate rises to 2%.
Market impact: we would expect a sharp knee jerk reaction lower in stocks, bond yields could also rise, which could put upward pressure on the EUR in the short term. Overall, we think a QE disappointment would be a long-term negative for the EUR, as it would increase pressure to take action in the coming months.
2) EUR 600-750 bn QE package
This would be more in line with what the market expects and would suggest that the ECB is serious about combatting deflation. A package of this size would also send a signal to the market that the German Bundesbank is on board with this package, which could be viewed as a long-term positive for the harmonious future of the currency bloc.
Market reaction: We would expect stocks to drift higher, particularly the FTSE 100 (see more below), and bond yields could also fall in the immediate aftermath. The Fed’s example tells us that sometimes the prospect of QE is a more powerful driver of a currency than the actual announcement of QE itself. Thus, after an initial knee jerk reaction higher in the EUR, we could see the EUR drift lower in the days after a QE announcement.
3) EUR 1 trillion QE package
This would be the big bazooka that the market is looking for. Markets love liquidity, so we may see a boost to overall market sentiment as it would signal that the ECB plans to step in and fill the QE void left by the Federal Reserve when it ended its QE programme at the end of last year.
Market reaction: same as above, but larger moves to the upside for risky assets.
Other policy options that the ECB may go for:
- Cutting the deposit rate further into negative territory: it is already at -0.2%, the ECB could follow the SNB’s lead, and rather than expand its balance sheet, opt to cut rates deeper into negative territory. This is unlikely to placate the market, who appear to want QE (or blood) from the ECB. A negative interest rate tends to have a long-term negative impact on a currency; however, it can take a while to weaken a currency, as we have seen with the Swissie.
If the ECB does announce QE:
If he does as the market expects and announces QE, then Draghi’s statement on Thursday, which begins at 1330 GMT / 0830 ET, will be the time when he announces the details that will determine the size of the market reaction. Things to look out for from his statement include:
- The size of the package: will it be big enough?
- The timeframe for purchases: Will the ECB opt for an open-ended programme or will it last a few months/ years? The latest rumour suggests that the ECB will announce a package worth EUR 50 bn per month, through to 2016.
- What assets will the ECB buy? Private sector assets will be the riskier end, which could stoke a lot of excitement in the stock market. Public sector assets are less of a concern since government bond yields have fallen so sharply across the currency bloc in recent years.
- How will the ECB split up purchases? Will it buy assets from all member states equally? Will it play it safe and only buy high quality assets from the Eurozone’s largest economies?
- Will there be risk sharing? This is likely to have been the hardest decision around the ECB’s QE programme. Risk sharing could trigger a stock market rally, particularly in Europe’s peripheral countries.
Will QE work in the Eurozone?
An announcement of QE is just the beginning, the questions around the size of the package, and risk –sharing in case of bad debt are key questions that could determine if it will be successful.
Previous studies suggest that QE is more effective than policies such as forward guidance when it comes to boosting growth and inflation, however QE can take time to work its way into the system, and it can take a lot of purchases to have an impact, so this may only be the beginning of the ECB’s QE journey, if it wants it to work.
Where will the money go?
When the Fed embarked on QE after the financial crisis, the liquidity it provided didn’t go straight into the real economy, instead it leaked out to other economies and asset classes. The same could happen to an ECB QE programme. In this instance, we think that the money could flow across the Channel and boost the UK housing market, particularly in London, and the UK stock market; it could also boost the gold price.
Gold could be a big winner from an ECB QE programme. Not only is the market jittery at the moment, which is good for a safe haven like gold, but a large QE programme could also stoke inflation pressures down the line. Since gold is considered an inflation hedge, this could boost the yellow metal.
Takeaway:
- The market expects QE – a major shock would be if it holds steady, this could cause a large jump in market volatility.
- The latest rumour is that the programme will be EUR 600 bn in size, with EUR 50bn of purchases per month through to 2016.
- There are still lots of unknowns – what will the ECB buy, where will it buy it from and will there be risk sharing?
- There is still a chance that QE won’t work in the Eurozone and instead the money could flow out and prop up global stock markets, like we saw when the Fed embarked on QE in recent years.
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