Thursday, January 21, 2016

Deflation: what leeway the ECB? – The echoes

In October, Mario Draghi had shown its determination to strike hard against the risk of deflation. When December came, markets had seen and been disappointed! Two months later, it is apparent muscles. The institution has “ no limit ” to the use of monetary policy instruments. What revive the imagination of markets that until now could only see the worst. To the point where we say that Mario Draghi may have been well advised not to grill all cartridges in December. Franck Dixmier, Allianz GI, “ it was urgent to intervene as a matter of credibility and it did. The challenge for Mario Draghi is to convince markets of its ability to respond to the risk of deflation, which is becoming increasingly important, while in the last two months we have seen a worsening of the economy and considerably increased uncertainty with increased political risk. So we waited for a response from the ECB, while inflation expectations have returned to the level before the start of the QE, there is a year . ” The ECB gives appointment in March, range of ammunition available.

– Lower still rates

In December, the ECB cut its deposit rates by 10 basis points . And she still has room. Valentin Bissat, economist at AM Mirabaud expects a further decline rates of 10 basis points in the ECB deposit rate to 0.40%. “ We read in the minutes of the ECB that some members had voted in December for a greater reduction in the rate. This is probably the main measure to be expected in March. This would have a significant impact on the yield curve and the exchange rate. This will reduce the imported deflation . ” According Quilvest, it might even descend to terms up to -0.50%. “ The most effective transmission belt compared to the low inflation is the motto, and the most effective tool is to lower the deposit rate ” Franck recalls Dixmier. In December, some also speculated on a dual-speed deposition rate to reduce the negative impact of this negative rates on smaller banks. Valentin Bissat does not believe too. It would be “politically difficult to pass. The French and German banks have plenty of cash on deposit unlike their Spanish and Italian counterparts. The ECB will be difficult to charge again the big German banks … “.

– Prolonging QE longer

The toolkit is still well-stocked with particular the possibility of extending the program of purchases in time , “said Franck Dixmier. She has already done once in December by extending the QE September 2016 to March 2017, six months longer, increasing its purchase program over the life of QE to at least 1,500 billion. Some are already waiting in December that the ECB sees further and extends the one-year program. So another six months in March?

– Buy more assets

The ECB will buy 60 billion euros a month until March 2017 . If it can increase the duration, it can also increase the size of QE. At 70? A 75 billion? All options are on the table. “ If you compare the size of QE from the Bank of England or the FED according to their GDP, the ECB still has room. It could go up to 100 billion per month until June 2017 to just upgrade to the Fed “according to Valentin Bissat. Buy more, but to buy what? At this rate, the ECB has already dried up the market for government bonds. The amount of the program is already higher than the net issuance in the euro area reminds Quilvest for whom “the is shrinking liquidity in these securities .” Franck Dixmier is also skeptical: “ The ECB will face difficulty to execute his plan. We are already 60 billion, which is considerable . ” But by lowering its rate to 0.4%, the ECB will also provide the opportunity “to broaden somewhat the pool of assets to buy ” Mirabaud note. “ Today it is limited and can not buy bonds that offer yields below 0.3%. .”

– Diversify purchases

This is a possibility, but the solutions are not so many. In December, the ECB had started to expand his horizon, including some bonds issued by local and regional authorities. Can it go even further by intervening in the credit market? Franck Dixmier question: “ This would create too much distortion on prices in a market that is already quite problematic .” Still less can imagine the ECB intervene in the High Yield market … To facilitate its work, it may also change the key of distribution of asset purchases (depending on the shareholding of the ECB by country). “ This would cause a lot of problems, with the risk of a referral to the Court of Karlsruhe for this would be seen as a way to directly fund the states ” Franck Dixmier away.

The ECB has still some cards in hand and the good news according Franck Dixmier is that “ Mario Draghi took over the house in hand. End of 2015, some members, including the Bundesbank, had argued their skepticism about the merits of QE to face deflationary pressures coming from the falling prices of raw materials. In preparing the ground for an intervention of the ECB in March, he put them to the wall . ” In this game, the ECB had disappointed the markets in December. In March, she will probably be more the right to make mistakes.

Pierrick Fay

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