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ECB Policy Outlook: Easing Bias and QE Expectations

Core Content

This document outlines the expected monetary policy direction of the European Central Bank (ECB) ahead of its July 2019 meeting, with a focus on forward guidance and potential easing measures. It also provides insights into the FX market implications and trade ideas based on the ECB's anticipated policy stance.

Main Viewpoints

ECB Policy Direction

• The ECB is expected to reintroduce an easing bias in its forward guidance during the July meeting, signaling a potential move toward rate cuts and the resumption of quantitative easing (QE).
• A change in forward guidance conditionality is also possible, which could imply a more proactive stance on monetary stimulus.
• The ECB is likely to delay actual rate cuts until later in the year, possibly in September or October, while using the July meeting to pave the way for such actions.
• The resumption of QE is anticipated for December 2019, with the possibility of an earlier announcement.

Market Response

• The ECB's forward guidance will be more significant than the actual decision in shaping market expectations.
• The threshold for action is a key focus, with the document suggesting that the ECB may move toward a more symmetric inflation target, indicating openness to both inflation above and below the 2% objective.
• A change in the language of forward guidance from "until inflation is on a convergence path" to "until inflation outturns are in line with the objective for a sustained period" would signal a more proactive stance.
• The FX market is expected to react to the ECB's easing bias, with the EUR likely to weaken against the USD and JPY, especially if QE is announced.

Trade Ideas

• Sell 7y Spain into 15y France: To capitalize on the expected flattening of the yield curve.
• Buy 30y Italy vs 30y Germany: To benefit from the ECB's potential easing and the relative value of Italian bonds.
• Sell 5y10y EUR/USD cross basis: To profit from the expected narrowing of swap spreads.
• Flattener 1y fwd 5s30s EUR swap vs USD: To exploit the anticipated shift in EUR/USD dynamics.
• Receive 10y20y EUR swap vs GBP: To benefit from the EUR's potential depreciation against the GBP.

Key Information

Dovish Scenario

• July: Easing bias reintroduced in forward guidance, possibly with a rate cut or tiering announcement.
• September: Potential 10bp deposit rate cut and tiering announcement.
• October: Another 10bp deposit rate cut.
• December: QE announcement, marking the restart of net asset purchases.

Hawkish Scenario

• July: No easing bias in forward guidance, possibly with an extension of the reinvestment horizon.
• September: No rate cuts, maintaining a reactive stance.
• No immediate easing is expected, with the ECB likely to wait for more data before acting.

FX Outlook

• The EUR is expected to weaken against the JPY more than the USD due to the ECB's potential easing and the limited flexibility of the Bank of Japan.
• The EURUSD pair is anticipated to benefit from broad USD weakening in the weeks ahead.
• The EURJPY is viewed as a short opportunity, given the BoJ's constrained policy space.

Risks and Considerations

• The risks to the call are skewed toward earlier action, especially if the ECB moves beyond just a guidance shift.
• The Governing Council may not fully align with the President's (Draghi) and Phillip Lane's urgent stance on easing, indicating internal debate.
• The Sintra speech has been seen as a pivotal shift in the ECB's policy posture, but not all members have embraced it, suggesting a higher threshold for action.
• The ECB's policy decisions are expected to be data-driven, rather than market-driven, in the near term.

Summary

The ECB is anticipated to shift its policy stance toward a more dovish approach in the coming months, with the July meeting serving as a crucial step in the process. The reintroduction of an easing bias in forward guidance is expected, which may be accompanied by a change in conditionality. While rate cuts are likely to occur in September and October, the QE announcement is expected in December. The FX market is expected to react with EUR depreciation, especially against the JPY, while EURUSD may benefit from USD weakness. The document also highlights internal disagreements within the ECB, with some members pushing for a more reactive approach, while others support a proactive stance. Trade ideas are provided to capitalize on these anticipated policy moves and market dynamics.