ECB: Broad based and solid economic recovery led to discussions about asset purchase program - Rabobank

In view of analysts at Rabobank, the upshot of yesterday’s ECB press conference is that the “broad based and solid” economic recovery has led the Council to start preliminary discussions about an adjustment in its asset purchase program (APP).

Key Quotes

“It expects “the bulk of decisions” to be taken in its October meeting. Although Mr. Draghi warned that “recent volatility in exchange rate [was] a source of uncertainty and requires monitoring”, the market did not perceive this remark as sufficiently forceful.”

“The robustness of the euro’s rally has led our FX Strategists to revise up our EUR/USD forecasts. We now expect a move to the 1.25 area by the middle of next year, compared to our previous target of 1.20.”

“In our view the market’s reluctance to take Mr. Draghi’s warnings very seriously is a reflection of the fact that the ECB will have to dial down its purchase program, regardless of the euro. It is being increasingly confronted with the self-implied limits to the program even though it does not want to acknowledge this. The issuer limits were not discussed, according to Mr. Draghi – and in the current economic and political climate we would argue this is a red line it cannot cross.”

“However, Draghi’s warnings over the exchange rate do imply that the Council will take this into account when making those important decisions in October. It may thus have a bearing on the adjustment amounts and as such this may be viewed by some market participants as being bond market ‘friendly’. That said, we believe the ECB does not have the room to simply extend the current program ‘as is’ into next year. To the extent that the ECB’s motivations are driven by technical rather than fundamental reasons (i.e. achievement of its inflation objective), there is obviously a risk that it dials down QE too quickly thus choking the expected “gradual rise” in underlying inflation, either through a too-strong an exchange rate or otherwise.”

“Our take is that the ECB will strengthen the prominence of its other instruments (notably interest rate policy) whilst it embarks on a gradual adjustment of its purchases next year. Mr. Draghi’s remark that the Council had not discussed ‘sequencing’ supports our view and may also help explaining the broadly positive reception of this press conference in bond markets.”

“While the ECB is evaluating its options, the US Fed is still trying to stick to its plan of another rate hike this year. After dovish remarks from a few FOMC members earlier in the week, yesterday Dudley, George and Mester all spoke their support for continuing gradual rate hikes. George, though admitting that inflation remains modest, pointed to the strong economy –particularly the ongoing tightening in the labour market– whilst Dudley noted that the weaker dollar should only be a temporary drag on inflation. These comments came as the markets continues to slowly pare back its expectations of another hike. Certainly, those with an interest in EUR/USD will keep a close eye on the 20 September FOMC meeting.”