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No limits to ECB’s willingness, but clear limits to its effectiveness – SocGen

Discussion in 'Fundamental Analysis' started by FXStreet_Team, Mar 1, 2016.

  1. FXStreet_Team

    FXStreet_Team Well-Known Member Trader

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    Anatoli Annenkov, Research Analyst at Societe Generale, suggests that despite its best efforts, the ECB’s challenge to break the backbone of lowflation remains a tall order.

    Key Quotes

    “Looking set to miss its target for a fourth year this year, we expect it to miss it for another four years, at least, without the help of more substantial economic reform. That won’t stop the ECB from doing what it must according to its self-imposed target, but with markets increasingly unconvinced, we are approaching the “effective” limit of the ECB’s tools. Long overdue, other policy areas will need to weigh in, including regulation. In this note, we examine the ECB’s various remaining options, concluding the following:

    Continued inflation headwinds call for more action. We expect another 20bp cut in the deposit rate in March, likely with the introduction of a two-tier charge on excess reserves, along with an extension of the TLTRO with a three-year maturity. We see the case for more aggressive easing as limited, but options to boost market confidence (activate a corporate bond purchase programme and expand collateral eligibility) could be considered. We expect the APP to continue until the end of 2017, when the investment outlook should look more promising.

    Increasing concerns over the trade-off and effectiveness of ECB policies suggest that we are approaching the “effective” limits of what the ECB can do. Having contributed sizeably to the reduction in interest rates and the euro, the lacklustre recovery in credit, investment, trade and inflation suggest a poor pass-through of its actions. While the lack of support from structural reform and regulation, and still high debt levels are among the key reasons, a gradual loss of ECB credibility could further weaken inflation expectations.

    Fiscal policy to be in focus in the next recession. Instead, we expect fiscal policy to be the key stabilisation tool in case of major shocks. The ECB would still have a key role to play, but likely only in emergency situations. Given the persistence of balance sheet recessions, we see merit in the idea of a troubled asset relief programme, financed by the ESM, for which the ECB could provide analysis and possibly limited purchasing support.

    Modifications to the inflation target framework likely for the next president. The strong defence of the current target formulation suggests little appetite for change. The length of time of undershooting will nevertheless threaten credibility and we see merit in a symmetric target of 2%, allowing for periods of longer deviation, in order to avoid overburdening monetary policy and reduce excessive market expectations.”
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