Importance of these minutes
There were four issues to look out for in the ECB’s minutes of the September meeting: how did the ECB assess the recent strengthening of the euro; did the ECB talk about the scarcity problem; how satisfied is the ECB with the current inflation developments and forecasts and was there any preliminary discussion on possible tapering scenarios? The just-released minutes gave answers to three out of these four issues. Only the scarcity issue remains unaddressed.
The euro, inflation and tapering
- As regards to the stronger euro, the ECB indeed had a longer discussion, suggesting that the strengthening this year had equally been driven by “demand, monetary policy and exogenous exchange rate shocks”. Interestingly, the euro appreciation up to now could “to some extent be seen as…reflecting more positive euro area developments…”. Also, concerns about the risk of an exchange rate overshooting were expressed. However, it does not seem as if the euro strengthening up to the September meeting had any impact on policy considerations.
- As regards to inflation, the minutes still sounded dovish with statements like “discomfort was widely expressed about the very prolonged period over which inflation had been – and was still expected to remain – distant from the Governing Council’s aim.” Also, the ECB sounded cautious on the outlook for wages, with the minutes pointing to “some downside risks to the wage outlook…not least in view of the persistent overestimation of wages in past projections.”
- As regards to the most important issue, tapering, the minutes show that the ECB indeed had a “preliminary exchange of views about the future monetary policy stance and the considerations that might guide a recalibration of instruments…”. Interestingly, the ECB calls this “recalibration” and not tapering. In our view, a clear sign that the ECB wants to divert market attention away from only QE towards the full monetary stance. This was also illustrated by statements like “…would provide an opportunity to scale back the Eurosystem’s net asset purchases”.
The minutes also show that the ECB had a first discussion on different scenarios, tweaking both “the pace and the intended duration” of QE.
What does this mean?
Recent political developments have put the ECB and the tapering discussion on the backburner. At least for the time being. However, with three more weeks to go until the next ECB policy meeting, the tapering discussion should gain momentum soon again. In our view, the ECB will first identify a targeted, final, size of the balance sheet before it derives paths towards this balance sheet target.
With the latest lawsuit at the German Constitutional Court, any extension of QE will preferably not have an open end. Against this background, there are in our view three potential scenarios for tapering: Fed-style tapering, the staircase option or lower for longer.
- Fed-style, the gradual tapering option. This option would see a linear scaling back of the asset purchases. Either per month or per quarter, with the latter providing more flexibility.
- The staircase option. Here, the ECB could reduce its monthly QE purchases in January by some 20bn euro, keep the purchases unchanged until June and then reduce the monthly purchases yet again by another 20bn euro until September.
- Lower for longer. Here, the ECB could reduce its monthly purchases by more than markets currently expect to about 20bn or 25bn euro per month, while at the same time extending QE until the end of 2018.
In our view, the ECB will opt for the ‘lower for longer’ option.
It would not only follow the pattern of the ECB’s first tapering decision in late 2016 but could also help anchoring interest rate expectations, in combination with emphasis on sequencing. Such a strategy could also help immunise the ECB’s monetary policy against further exchange rate fluctuations. All in all, even though the outcome of the ECB’s September meeting looked a bit disappointing, the discussion at the EuroTower already seems to have been lively. It looks as if the September meeting was the last stop before the ECB will announce first details of its dovish tapering at the meeting on 26 October.