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Harbour Navigator - The prospect of more ECB stimulus

20 January 2015 / / +64 4 460 8300

At the end of 2014, the US Federal Reserve signal led that it was planning to remove stimulus by lifting interest rates. As we start 2015, global attention has turned 180 degrees to the prospect of the European Central Bank (ECB) adding more stimulus, through a comprehensive program Quantitative Easing (QE). The stakes were raised last week by the Swiss National Bank’s surprise decision to abandon its peg to the euro. All eyes now turn to the ECB meeting on 22 January.

In September, Mario Draghi first hinted that the ECB may need to consider a large scale QE program, including purchasing European sovereign government bonds. Since then, Europe an economic activity has disappointed, European inflation has continued to fall, and the decline in oil prices has raised the spectre of deflation. With deflation in sight , the focus is not ‘if’ the ECB will embark on QE, but ‘when’, ‘how much’, and ‘what type of assets’. Expectations are building.

  • When? The next ECB meeting is on 22 January. Even if the ECB does not start purchases straight away, to not disappoi nt the market they will need to announce a scheme with as many details as possible , and follow up quickly with other details.
  • How much? In September Draghi hinted at expanding the ECB balance sheet to its early 2012 peak. That implies a 1 trillion euro expansion. Even if the ECB do not q uote a number in their package, and leave it open - ended, it will need to look capable of providing comprehensive stimulus.
  • What type of assets? The ECB already have programs where they are buying ABS and sovereign bonds, and various liquidity programs. Any or all of these could be expanded. The European Court of Justice ruling last week paved the way for purchases of sovereign bonds, which is what the market wants to see (subject to managing the risks from Greece and other problem member countries).

The stakes were raised last week by the Swiss National Bank’s (SNB) surprise decision to abandon its peg to the euro. On one hand it appeared to be good news, by hinting that Swiss decision was prompted in part by the in evitability of more ECB stimulus. On the other hand, the SNB decision caused extreme FX market vola til it y and illiquidity, highlighting the fragile state of markets, especially on the he e ls of extreme price movements in commodity markets.

Markets will in itially be focused on the precise details of the ECB’s QE package. However, the real question is whether it will be successful in prompting a turnaround in the fortunes of the European economy, in the way it has in the US and the UK. At the moment, it is hard to find a European optimist. It is true that Europe still faces many structural challenges, including high government debt and inflexible labour markets. However, the region should eventually see the benefits from the weakness of the euro. Any evidence of this in upcoming macroeconomic data would test the pessimists.

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Harbour Navigator- The prospect of more ECB stimulus

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