Natixis IM: ECB Talking Points

9 september 2019

By David Lafferty, Chief Strategist at Natixis IM

• The malaise across Europe is largely one of limited aggregate demand. The problems are structural. Super-accommodative monetary policy can create a positive backdrop, but it can’t directly remedy the structural problems facing Europe’s economy. Central bankers understand this, but they can’t be seen as pulling back or throwing in the towel. As such, more monetary stimulus is coming, but it is likely to underwhelm. 
• Lower rates won’t induce worried consumers or cautious CEOs to borrow if they believe the economy is on a near zero-growth trajectory – or worse, a recessionary path.
• The ECB is more tapped out than they can acknowledge publicly. The bank can throw a few more euros at the problem, but the effects are likely to be modest going forward. While doing nothing is not an option  - with both Germany and Italy bordering on recession - recent comments from some quarters indicate that their actions will be more modest.
• As result, we expect the ECB will announce several policy adjustments on Thursday, trying to win over markets with breadth of action instead of magnitude. Some or all these changes are likely to be at the lower end of expectations.
• The ECB is likely to cut the overnight deposit rate by another 10 to 20 bps.  A cut of 10 bps seems somewhat more likely if only to mitigate the pain on banks and preserve some ammunition should the economy weaken further.
• Banks may enjoy some relief as we expect the ECB to outline a deposit tiering method.  If deposit tiering comes with sufficient details and size, this could be a real shot in the arm to European bank stocks, although it’s impact on the real economy will be modest.
• Most estimates are for the ECB to renew asset purchases in the EUR25 billion – EUR50 billion per month range. With few assets left to buy, we suspect this will underwhelm too, closer to the EUR25 billion level. Perhaps the greatest market risk is that ECB doesn’t announce an expansion of the QE program at all. This is possible, but risky given expectations, so we think something smaller is more likely than nothing. Doing something on the higher end of the range is also possible, but unlikely. To do more, the ECB would have to lift the country issuer limit to 50% from the current 33% and that is probably a bridge too far for the Bundesbank and others. Consistent with continued forward guidance, a smaller (fewer euros) but longer (more months) asset purchase program is our base case.
• There is an upside to the ECB exhibiting some restraint – It might force the core European states to take fiscal expansion more seriously. With rates already in negative territory, additional bond issuance is effectively free. Proceeds could be targeted at projects to boost long term productivity and it would create more sovereign supply for the QE program. The hand-off from Draghi to Lagarde in November is likely to usher in a new phase at the ECB – continued accommodation yes, but with more pressure on EZ countries to step up on the fiscal side. The ECB can longer be the only game in town.