ECB: Moving to a new reaction function – Deutsche Bank

According to Deutsche Bank analysts, Mario Draghi remains the best leading indicator of ECB policy as he sharpened the dovish message at Sintra and yesterday he persuaded the Council to take a significant step towards delivering on this message.

Key Quotes

“As we suspected, efforts to strengthen the commitment to price stability by elevating the symmetry of the inflation target played a significant role. This evolution of the reaction function was just one element in today’s communications, however.”

“The Council also formally endorsed the full set of policy options by tasking the Committees to study the possibilities for further easing using rates/mitigation, asset purchases and forward guidance. As expected, we are heading towards a policy easing package in September.”

“The latest policy communications were a tale of two halves, however. In a departure from the norm, the Policy Decision statement was used to convey the primary policy message. There was an opportunity for Draghi to reinforce the dovish tone in the press conference, but the Q&A did not achieve this. If anything, the effect was the opposite. In that sense, Draghi has only half delivered on Sintra. He now has seven weeks to convince the Council to keep with him and deliver a strong enough easing package. Given his powers of persuasion, we don’t doubt him.”

“We are updating slightly our baseline expectation for what the ECB will announce in the coming months. We continue to expect a 10bp deposit rate cut and tiering in September and a further 10bp cut in December.”

“New net asset purchases we thought were a close call but were not in our baseline – we thought the ECB would have a preference for upgrading forward guidance first. In light of both the breadth of the Policy Decision statement – a sign of Draghi’s powers of persuasion – and the worrying signals on the external side of the economy from the latest PMI and Ifo data and the ECB’s sensitivity to this, we are including new net asset purchases in our baseline view for September.”

“We expect EUR30bn per month for a minimum 9-12 months split evenly between public and private assets. New QE is still a close call. If data and events surprise to the upside in the meantime, the ECB could stall on this element of the easing package.”