– Talk of tapering is cheap – cheap analysis that is.
– Several ECB policy officials have made clear *more* easing is possible, and that even discussing *less* easing is nonsense.
Ahead of the October ECB rate decision today, several market observers have suggested that the ECB is getting ready to taper its QE program. Seemingly, the basis of this analysis is that the ECB has yet to extend its QE program; so that in turn, this must mean it’s getting ready to taper. We think this is a cheap explanation for what the ECB may be thinking of doing, particularly with several pieces of evidence that suggest otherwise.
In August, at the Federal Reserve’s Jackson Hole Economic Policy Symposium, ECB Executive Board member Benoit Coeure said that “if other actors do not take the necessary measures in their policy domains, we may need to dive deeper into our operational framework and strategy to do so.” Translated from his economic jargon: “if politicians don’t stop fooling around, then the ECB will have to ease again.” Does anyone really think political developments in Europe are allowing fiscal policymakers to do more?
In September, at the press conference after the ECB’s rate decision, ECB President Draghi made an important comment. “We tasked the relevant committees to work on the smooth implementation and the changes that are needed to ensure the smooth implementation,” he said. In other words, the ECB is not focused on the size of the QE program right now, but rather, whether or not its functioning properly.
More recently, as pointed out in a Bloomberg Brief last Friday, over the course of the prior week, two separate ECB officials spoke about the ECB’s QE program and the timetable of tapering. ECB Vice President Vitor Constancio said the Governing Council “has not discussed anything about the timetable of QE.” Similarly, the ECB’s Vitas Vasiliauskas (a more hawkish policymaker) said “it is very important not to speak about exit,” ‘exit’ being the end of the QE program. If there is an adjustment announced at some point, it will be to adjust the QE program to ensure that it can run for longer (in other words, to make sure it is sustainable and won’t need to be tapered abruptly).
What will likely happen: at either an upcoming meeting (perhaps today, even) the ECB will indicate that it needs to adjust the way its bond buying program is conducted. The ECB allots its bond buying based on the capital key. What is the capital key? The capital of the ECB comes from the national central banks (NCBs) of all EU member states. According to the ECB, the NCBs’ shares in this capital are calculated using a key which reflects the respective country’s share in the total population and gross domestic product of the EU.
As such, it’s no surprise that Germany – as the country with the largest capital key contribution – has seen the belly of its yield curve (3Y-7Y) drift lower into negative territory, below the ECB’s -0.40% deposit level – the threshold at which the ECB no longer purchases bonds in its QE program. Likewise, the ECB needs to either: remove the limiting parameter of -0.40% on its bond buying; or discard the capital key variable. In the first case, German yields would like move lower the fastest; in the second, peripheral yields like in Italy and in Spain. In either case, the potential for a signficant Euro move absent a notable driver – like a rate cut – seems limited (15% chance per OIS).