The ECB Delivers a Thoughtful Dovish Stimulus Package

Online trading of the currency markets experienced a surprise on Thursday as the ECB delivered a thoughtful decision that set the stage for tapering of bond purchases while delivering a larger than expected stimulus package. The EUR/USD whipsawed first moving higher but as the market realized the extent of the dovish package, the currency pair tumbled. While the market had prices in an extension of QE for 6-months, few believed that the extension would reach 9-months with a decline in the purchases from 80 billion per month to 60-billion a month. The markets would have stumbled with a tapering of QE and an extension of 6-months, which is why the ECB was clever in its approach.

Draghi left rates unchanged, as expected and the extended QE program settled on a compromise with monthly purchases scaled back, but the overall time frame of the program extended by 9 months rather than the expected.

The ECB announced a further extension of the QE program pushing the total program amounts to asset purchases of 540 billion Euros. This is more than the 480 billion a 6 months’ extension at EUR 80 billion per months would have amounted to and the ECB actually left the door to a further increase of monthly purchases volumes and the overall program length open, depending on actual developments.

This does give the ECB added flexibility as Brexit negotiations start in earnest and with a longer program and the option to lift purchases Draghi’s main message was that the ECB will remain active in markets for the foreseeable future. The ECB President was very keen to stress that a tapering in the sense that purchases are being gradually scaled back to zero. The program extension of 9 months and the ECB stressing that purchases won’t end abruptly it is already clear that there will be another follow up program when the new QE extension ends in December 2017 and that the central bank will continue to remain active in markets and influence interest rates well into 2018.

To achieve this objective, without violating the no-bail out clause and move away from the self-imposed rule to keep the distribution of purchases across countries the framework for eligible assets has been tweaked as well. The minimum duration for bonds was cut to just 1 year from 2 years and at the same time, the ECB now can buy bonds yielding below the deposit rate of -0.4%.

All this even though growth is ticking along and in fact broadening, unemployment is coming down faster than expected and inflation is picking up. The ECB’s new set of staff projections see GDP growth this year still at 1.7%, while the forecast for 2017 was lifted to 1.7% from 1.6% seen back in September. The forecast for 2018 was left unchanged at 1.6% and the new forecast for 2018 is also 1.6%. At the same time inflation is seen rising to 1.3% next year, 1.5% in 2018 and 1.7% in 2019, although while this already seems close to 2% Draghi was at pains to stress in the press conference.

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