ECB President Draghi sent an unambiguous signal to investors. Although the economic data from the region has been largely stable, the downside risks have grown, and the ECB will take action at its next meeting, which is in early December.
In the past, Draghi has indicated that the negative 20 bp deposit rate exhausted the scope for rate cuts. However, he did reveal that the possibility of another cut in the deposit rate was discussed. The key takeaway point is that the “degree of easing” would be re-examined at the December 3 meeting in its entirety.
It was not only that Draghi was more dovish than the market expected, but his comments made it appear that the ECB was closer to a consensus than many expected. He revealed that some members wanted to take action immediately. Still, even if the ECB announces its intention to provide more monetary stimulus in December, the launching of the new effort is unlikely to start until early 2016. That said, it would not be surprising if in the coming days, the less dovish ECB members like the Bundesbank’s Weidmann, resist the push.
Most observers have been focused on extending the length of the asset purchases. We have been skeptical of the effectiveness of extending a program that is not even half complete. It essentially concedes that the current purchases are insufficient. Increasing the size of the current operations seems to be the more logical course. That is what the Bank of Japan did last October. However, there is a concern that it might exacerbate a shortage of some instruments, like German bunds. This has been a concern since the asset purchases plan was announced, but thus far there is only marginal evidence of this. Consider that 10-year German bund yield has risen 33 bp over the past six months.
Still, under the ECB’s program, instruments yielding less than the (minus 20 bp) deposit rate cannot be included in the official purchases. After yesterday’s rally, German yields from one through four years are lower than -20 bp. The two-year yield set new record lows near -32 bp. Reducing the deposit rate further would free up more instruments that can be bought, theoretically.
