The European Central Bank cut its deposit facility rate by 10bp to -0.50% and relaunched a sizable APP at its meeting yesterday. The market reaction was mixed – EURUSD dropped to YTD low during the press conference, but rallied strongly in the aftermath, possibly due to closing of the speculative short term positions.
Mario Draghi managed once again to reconcile opposing fractions within the ECB’s Governing Council and delivered what is generally considered a strong stimulus package. The deposit facility rate was cut by 10bps, as expected, but the dovish part starts with the introduction of deposit tiering designed to offset part of the ”parking costs”. About 800b EUR out of the 1.8 trillion EUR of excess reserves would be exempt from -0.50%, but this is just the starters and might be increased down the road.
The Governing Council also decided to reintroduce QE in size of 20b EUR/month, which is 10b EUR less than the market expected. On the other hand, asset purchases are designed to be open ended, which is the reason why one of the journalists on the press conference dubbed it “QE ad infinitum”. Open ended QE is probably going to run into bottlenecks stemming from capital keys and issuer limits, and removing these obstacles might be more difficult than some think. This is not the only thing that’s left open ended – the calendar date of forward guidance has been scrapped (no “middle of 2020” mentioned) and instead a more data dependent wording was introduced, stating that lower rates would remain until “inflation outlook robustly converge to a level sufficiently close to, but below, 2% within the projection horizon, and such convergence has been consistently reflected in underlying inflation dynamic”. With current deflationary environment, nursed by demographic aging, dropping PPIs in China, trade wars etc., accommodative monetary measures might stay with us for a longer time than some of the core central bank governors think. Bond markets zig-zagged with Bund yield first dropping to -0.64%, but then staging a strong reversal and rising all the way up to -0.496%, the level seen for the last time in the beginning of August. Equities rallied as well, but some of the price effect on share prices came from the direction of conciliatory trade talk between US and China, which is exactly the story that financial markets would be focused on today. The next big date on the global central bank calendar would be next Wednesday (September 18th) when markets expect FED Chairman Powell to deliver new rate cut.
