ECB: On hold next week, more easing possible in September - LLoyds

Analysts from Lloyds Bank consider that the European Central Bank is likely to keep monetary policy unchanged at the July 21 meeting despite the increase economic downside risks following the Brexit referendum.

Key Quotes:

“It is still too early to assess their impact and also the possible effects of Brexit. As such, the ECB is likely to keep policy unchanged at its next meeting on 21 July. Further stimulus, if required, could be announced as soon as the following meeting on 8 September. The least contentious option in September (or later) would be to extend the explicit end date of the asset purchase programme beyond March 2017, although the end date is ‘soft’ and would be extended in any case if the inflation outlook remains weak. This, however, could run into the increasing risk of a scarcity of German government bonds available for purchase, given that a significant proportion now yield below the deposit rate, though this may not become acute until early next year.”

“A number of options are potentially available to policymakers beyond next week’s meeting. They include cutting interest rates further (OIS curve pricing 56% probability of at least a 10bps deposit rate cut at the September meeting), removing the deposit rate floor on purchases, raising issue limits and changing the capital key (which weights asset purchases according to the size of the country). Each of these has potential drawbacks, including political opposition and the possible impact on banking sector margins. The choice that the ECB may eventually make could also depend in part on the scale and nature of any Brexit impact. Changes to the capital key, for example, would more likely be supportive of peripheral debt to counter any financial market contagion risk, while some of the other measures are more likely to benefit core debt.”

“For the 21 July meeting, the ECB is likely to remain in wait-and-see mode, with the OIS curve pricing only 18% chance of a 10bps deposit rate cut. Instead, it will be assessing the effects of its current stimulus measures on reducing the cost and increasing the flow of credit to Eurozone households and firms. Whether there is sufficient appetite for credit demand might require policy actions outside of the ECB’s remit.”