Despite the immediate reversal in EUR/USD and the Dax, today’s press conference sets up nicely for QE in first quarter of next year. Why?
1. Significant downward revision to GDP and Inflation forecasts:
GDP: 0.8% in 2014, 1.0% in 2015 and 1.5% in 2016 from 0.9, 1.6, 1.9
HCIP: 0.5% in 2014, 0.7% in 2015 and 1.3% in 2016 from 0.6, 1.1, 1.4
2. And that’s before the recent oil price decline since OPEC failed to deliver production cuts.
3. For Draghi to mention this explicitly, he must fear that inflation might register a negative print
4. Flagging that up now means that he can show that they did expect it, and don’t worry, they have a plan – which he is going to bounce the hawks into.
5. Hence the obsessive references to the word “Mandate” which featured heavily in Draghi’s responses.
The ECB only exists to deliver price stability – ‘inflation close to but below 2%’. No-one at the ECB can be under any illusion that 1.3% in the longer-term is hardly just below 2%.
6. “We will not tolerate prolonged deviations from price stability“.
What constitutes prolonged? Not just one month, hence his reference that they won’t do something at the next meeting. But 2 or 3 months time? With maybe a negative CPI print in there? Yep, that’ll do it.
7. QE is on the agenda. They had a “rich discussion” about it, apparently (!). Better that they have this argument now, and then get something together in the start of the new year
8. “We have to comply with our mandate, we are not politicians… We do not need unanimity” to deliver QE. “We have delivered significant decisions in the past that were not unanimous“. In other words: this is a threat to Germany that they had better get on board or he will proceed without them, such is the risk of not meeting their mandate.
9. The longer they wait, the tighter monetary policy actually gets, with inflation so low meaning that real rates creep higher.
‘we have to remember that we have a mandate, we don’t tolerate prolonged deviations…that create an unwanted tightening‘
10. The delay over QE is that he has to convince the Germans it is not in violation of Article 123 (he referenced this directly) which prohibits monetary financing of states. Hence he said that it’s important to note OMT is different to QE. After all the German constitutional court tried to throw OMT out… thank goodness it was never activated.
11. The 1trillion Euro plan to increase the balance sheet has been upgraded from an “expectation” to an “intention”: ‘our measures will have a sizeable impact on our balance sheet, which is intended to move towards the dimensions it had at the beginning of 2012.’ This is the equivalent of taking the car out of 2nd gear and into 3rd… not yet pedal to the metal but in ECB time, it’s getting there.
Overall, the entire Q&A was reflective of his November 21st speech, where he said: ‘a channel I particularly want to focus on is the risk that a too prolonged period of low inflation becomes embedded in inflation expectations’. He even answered one question today by referring back to this sentence from the ECB statement: ‘All of our monetary policy measures are geared towards underpinning the firm anchoring of medium to long-term inflation expectations’
So the stage is set.
– Inflation is likely to remain low.
– Their mandate is threatened, even more so by the fall in the oil price.
– The longer they wait, the more that monetary policy tightens, as real rates rise with inflation so low.
– They are in heated discussions over how to make QE adhere to Article 123.
– He is threatening to go ahead without everyone on board.
– Therefore, they had better come up with something.
If you think inflation is set to remain low, then QE is coming…
Meanwhile the Fed are happy about the fall in the oil price because it boosts the consumer. Monetary policy divergence is even stronger than it has been (Draghi referred to this divergence today). In EUR/USD there are sizeable option expiries between 1.2400-1.2500 – if/when we get up there, look to sell it.