Here, we analyse eight of the more popularised monetary options for the European Central Bank, listed in order of decreasing probability.
1. Publication of minutes (80% probability)
In our view, there is a high chance the ECB will introduce minutes for its monetary policy meetings, with the proviso that the Governor’s independence is not sacrificed over transparency.
2. Liquidity provision (60%)
A new programme based on credit distribution to smaller entities also boasts a strong level of probability, as lending to the private sector is becoming of more concern than low inflation. Such a programme, similar to the Bank of England’s ‘Funding for Lending’ scheme, would replace the big liquidity injection via VLTROs (very long-term repayment options).
3. Cut in reserve requirements (50%)
Faced with tensions over excess liquidity and its upward effect on money market rates, the ECB could again lower reserve requirement ratios. Indeed, a reduction of half a point – from 1% to 0.5% – equates to around €50bn of additional liquidity. Furthermore, this measure would be relatively easy to push through and enact.
4. A change in forward guidance (40%)
The ECB could adjust its forward guidance on policy interest rates to anchor expectations at a low level. We give this a relatively low probability, however, because the ECB does not seem entirely convinced by the Fed or the Swedish central bank Riksbank’s versions of forward guidance.
5. A cut in policy interest rates (30%)
As long as deflationary risk remains contained – with inflation remaining at low levels, but not on a downward spiral – it is quite unlikely a further cut in policy interest rates would be implemented.
This is because, although average inflation expectations still languish behind the ECB’s inflation target of below but close to 2% (1.1% in 2014 and 1.3% in 2015), the central bank believes the risks threatening price stability are “broadly balanced“, with several Governors believing there is no visible deflation in the eurozone.
In addition, the benefit of negative rates seems more hypothetical than the associated risks. In fact, an unfavourable deposit rate would accelerate VLTRO repayments and lead to a rise in euro overnight interest (EONIA) rates.
6. Purchase of private sector assets (20%)
The Governing Council could expand its balance sheet via securities purchases. But such a strategy needs liquid markets, and these are mostly found in core countries – many of which are undergoing a liquidity reimbursement. In addition, the purchase of private debt securities may actually pose more technical problems for the ECB than repurchase agreements for assets of the same type.
7. End of SMP sterilisation (10%)
If sterilisation was halted, it would free two to three times the amount of liquidity a reduction in reserves could (almost €185bn verss €50bn). However, this would contravene the non-financing statutory principle of states, which Germans in particular hold so dear.
8. Sovereign bond purchases via OMTs (5%)
This option would only be used to combat the risk of eurozone fragmentation, which is a risk that is clearly receding.
To conclude, the ECB could take additional measures in the short term – such as the publishing of minutes, a new mechanism for liquidity provision, or cuts in reserve ratios. But, a further cut in the repo rate and/or the more heterodox measures – such as negative deposits, asset purchases or even sovereign bond purchases via the OMT programme – are only likely to be applied if deflationary risk increases substantially, which we do not expect to happen any time soon.
