Here comes the cavalry!

Mea culpa, screams the ECB. They didn’t mean not to do anything much in December after all. They just didn’t like that Draghi teed them up in October in his Q&A, without consulting them first. This huffy fit from the ECB hawks led to the biggest one-day move in EUR/USD of 2015, so thanks for that, guys (and who said women are the ones who get moody??). Anyway the upshot now is that all of the ECB are back on board the Draghi kitchen-sink easing train again.

Sure, we might now doubt their commitment. Once bitten by a massive stop-loss, twice shy. But the presentation this month was very different from the October meeting, suggesting that the ECB have indeed learnt their lesson. The very first line of the opening statement finished with: ‘we decided to keep the key ECB interest rates unchanged and we expect them to remain at present or lower levels for an extended period of time’ [BM emphasis]. That’s new.

Then the 3rd paragraph sets it up nicely:

‘Yet, as we start the new year, downside risks have increased again amid heightened uncertainty about emerging market economies’ growth prospects, volatility in financial and commodity markets, and geopolitical risks. In this environment, euro area inflation dynamics also continue to be weaker than expected. It will therefore be necessary to review and possibly reconsider our monetary policy stance at our next meeting in early March, when the new staff macroeconomic projections become available which will also cover the year 2018′

In March, they will present new governing council forecasts. Later in his speech Draghi said that he expected inflation to be flat or even negative in 2016, so there’s a pretty strong likelihood those inflation forecasts aren’t going to be higher.

Now, you could say that yet again the ECB have responded to an oil price dive and its impact on spot inflation, whereas they should be thinking about inflation over the long term horizon. Yes, but that’s not the ECB’s way. They are one of the most coincident central banks when it comes to inflation. You could say Draghi underwrites an oil put, just as Greenspan wrote a put for the US equity markets.

Of course, if we took that to its logical conclusion, you now have a central bank introducing some serious auto-correlation. Risky assets immediately rose yesterday on the suggestion of another boost to the seeminly never-ending central bank glut of extra liquidity. Oil was one of them. Now, if oil were really just demand/supply led, and all the recent woes in equity markets are supposed to be due to China etc dropping their demand, then an extra bit of bond buying by a European central bank should be neither here nor there. But evidently some of the oil price fall was speculatively driven. We are about to find out just how much.

So – let’s take the correlation on….

Oil falls, inflation drops, inflation expectations might get stuck in what Draghi flagged yesterday as a “downward spiral”.
Fresh easing from the ECB means risky assets, including oil, rise in price.
Does this mean that by the March meeting, oil will have stabilised, and then the ECB no longer need to act?
If so, at what point does the market spot this and start discounting it?
Talk about central banks eating themselves.

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