For Deutsche Bank’s Jim Reid, there is – to put it mildly – a lot riding on what the ECB announces in just about 10 mintues. Recall it was DB just a month ago when, with its stock plunging to near record lows, the bank issued an appeal to the ECB: “Stop Easing, You Are Crushing Us.” As it later turned out, all Deutsche did not want is more negative rates, and was perfectly ok with more QE or a two-tier system, but more NIRP by Draghi seems unavoidable. Which is why as Reid asks, “is today’s the most challenging central bank meeting in living memory.”
From Deutsche Bank’s Early Morning Reid
Is today’s the most challenging central bank meeting in living memory? The reason we say this is that up until now virtually all meetings have rested on will they or won’t they ease and if they do by how much? Even in a crisis central banks have generally been able to get bang for their buck by easing more than expected. However there seems to be more at stake for today’s ECB get-together. It’s the type of easing that matters. Easing in standard post-GFC manner (i.e. further rate cuts and more QE) may not meet expectations. To beat expectations they may need to find some way of easing credit conditions for banks. However as markets have recovered in recent weeks and with the ECB reluctant to be seen to be writing a cheque to the banks it’s an incredibly difficult meeting to call for economists and strategists or get right for the ECB.
DB thinks we’ll see a two-tier system producing a cumulative fall in the Eonia rate of about 10bps. Note that this implies a much larger cut on the rate attached to the lowest tier. Secondly new TLTRO auctions until the end of 2017 is expected. To further incentivise lending the ECB could decide to introduce a dedicated negative refi rate only for the TLTROs but there remains the risk that the Governing Council sees a negative refi rate as an unwarranted relief for banks. Thirdly, the Governing Council could compromise by agreeing upon a temporary EUR 10bn acceleration in the pace of its monthly QE purchases.
At the heart of why the ECB needs to act is their increasingly persistent miss on inflation. Even though it shouldn’t be solely their responsibility (governments should have a big role to play too), the modern era is one where central banks are the inflation guardians. In the PDF today we show European, US and UK inflation since 1999 relative to where it would have been had we seen a constant 2% number. We show this for headline and core just for interest.
Interestingly cumulative headline CPI in Europe kept ahead of this 2% bogey until March 2014 but has now seen prices broadly static for 2-3 years or so. So the miss is slowly compounding and prices have now been stuck for long enough to be a major concern. For comparison headline inflation in the US has been above this line consistently since 1999 but to be fair core inflation has tightly hugged the hypothetical constant 2% growth line. Core inflation in Europe has consistently been lower. The graphs are simplistic but tell a story
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