More ECB QE? Perhaps best when the Fed raises

October 22, 2015

Those clamouring for the European Central Bank to ramp up its 60 billion euro per month stimulus programme will have to wait until December.

It just so happens that is not only when the ECB next takes a look at its growth and inflation forecasts, but it’s also when economists still expect the U.S. Federal Reserve to hike rates for the first time in nearly a decade.

After euro area inflation turned negative in September and the ECB downgraded its growth forecasts for the next two years, the only obvious remedy to many appeared to be more quantitative easing.

That has, after all, been a mantra many developed nations have followed since the global financial crisis when faced with economic troubles: more easing.

But as a euro money market trader said:

This (QE) is a tried and tested method that has failed in many areas of the globe so far and I don’t think there’s any reason why it should necessarily function here. The instruments they have at their disposal seem to be very limited.

If the ECB’s policies are to have the greatest impact possible on the exchange rate — which its President Mario Draghi stressed yet again on Thursday is not a policy target — the more effective way would be to loosen just as the Fed tightens.

The euro should then weaken more significantly, making exports cheaper and imports costlier, which might help send inflation up from zero, at least a little bit closer to the ECB’s 2 percent goal.

All but one of 20 money market traders polled by Reuters earlier this week correctly predicted no change to the ECB’s QE programme on Thursday.

But Draghi left the door wide open for more QE, prompting confident predictions the central bank would announce in December either an expansion or an extension of its stimulus beyond September next year. 

Ken Wattret, Co-Head of European Market Economics at BNP Paribas wrote:

To sum up, the communication at the press conference was as dovish as it could have possibly been without announcing more policy easing at this meeting – message received and understood.

Eyes down for action on 3 December – it’s merely a question of the form it takes.

The logistical challenge is the ECB is scheduled to meet before the Fed does in December, so it won’t know for sure where Fed policy is headed when it sets its own. And doubts over whether the Fed will pull the trigger this year at all — despite protestations from several prominent Federal Open Market Committee members that remains their intention — are intensifying by the day. Financial markets don’t expect a move until well into 2016.

But weakening the euro further seems to be one of the few options the ECB has left. It will fall over 7 percent against the greenback over the next 12 months, according to median forecasts in the latest Reuters poll.

EUR poll

Should that prove true, the euro will have lost more than 20 percent of its value over 2014 and 2015, making it the first time since its inception that it has shed more than 10 percent in two consecutive years.

That may be a tall order — but much easier for many to picture if the Fed actually lifts rates off the zero bound.

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