We’re minutes away from the interest rate decision from the European Central Bank, so it may be a good time to wonder how the exit strategy from the massive stimulus could look like in the European Monetary Union. Rabobank comes with its own point of view.
Analysts at Rabobank believe that the balance of pros and cons for ECB is still substantially skewed in favour of ending quantitative easing before hiking rates. The bank has pencilled in gradual improvements in the ECB’s forward guidance throughout the year, but with emphasis on the second half of 2017.
After the removal of the promise to “use all instruments within its mandate” in March, Rabobank expects the ECB to also adjust its rates guidance. Another signal the Governing Council may use is its economic outlook. The most subtle signals would come in the form of an upgraded long-term forecast for growth and/or inflation.
Upgrading the risk assessment –to broadly balanced or even upside risks from the current downside risks– would probably be interpreted as a signal of imminent changes in the ECB’s policy stance, and we therefore expect this part of the ECB’s communication to be adjusted only relatively shortly before the ECB is ready to pull the trigger on tapering. The bank expects the start of tapering to be announced at December 2017 meeting, which would make the September or October meetings as most plausible dates for an upgrade to the risk assessment.
According to the interest rate market the ECB may hike its rates in the second half of 2018. source: Bloomberg
In terms of tapering, Rabobank expects the ECB to wind down its net new purchases over the first half of 2018. They believe the Governing Council will prefer to announce a new monthly pace at every meeting, rather than to commit itself to a pre-determined tapering path. Whilst markets will probably extrapolate the first cut to project future decisions (and so it shouldn’t differ too much from a fixed pace in that sense), this provides the ECB with more flexibility. In addition, it is slightly less of a hawkish shift compared to announcing an intended end-date at the start of the taperprocess. Given the 6-weekly meetings, this should translate in a downward adjustment of roughly 15bn per meeting.
Following the completion of tapering, the ECB will likely take a breather before it continues to normalize interest rate policy. Rabobank expects the focus to be primarily on reverting the negative deposit rate policy. Starting with an announcement in December 2018, they imagine the Governing Council to gradually hike the deposit rate back to zero over the first half of 2019, after which they may take another pause before further normalising rates.