Today’s meeting of the ECB’s Governing council was a relatively low key affair

ECB sets out details of last month’s asset purchase schemes but no promise of further action.

• Mr Draghi emphasises continuing concerns about activity and inflation.

• So bias towards further easing still evident.

• Desire for weaker currency clearly signalled (at least clear for a central bank).

• Mr Draghi attempts to switch focus from size of asset purchase scheme.

As always seemed likely, today’s meeting of the ECB’s Governing council was a relatively low key affair. That said, it seems Mr Draghi and his colleagues disappointed some market hopes for a strong signal that further measures would be taken to support the beleaguered economy of the Euro area and thereby push inflation closer to the ECB’s target of under but close to 2%.

The immediate market reaction which saw little change in the Euro against the Dollar, a slight uptick in bond yields and some modest selling of European equities suggests a fairly dull and marginally disappointing outcome to today’s ECB deliberations. This was likely the desired outcome of the Governing council. However, the movements seen later in the European session--entailing a significant sell-off in equities and a slight rise in the Euro against the US currency-- can’t have been envisaged unless the ECB was anxious to dampen expectations of aggressive further moves in the very near term.

ECB Still Worried About Weak Activity And Inflation

While Mr Draghi avoided painting himself into a corner, we sensed a significant level of concern today about the outlook for activity and inflation. We think that downside surprises in the next couple of months could prompt further ECB initiatives sooner than the market might now expect. We also detected a clear intention (in so far as a central banker can be clear in these matters) to encourage a further weakening of the Euro on FX markets.

There wasn’t any marked change in the ECB’s assessment of the economic outlook from a month ago but recent data were judged to ‘confirm the weakening in the Euro area’s growth momentum while remaining consistent with a modest economic expansion in the second half of the year’. Notwithstanding its recent and impending measures, the ECB continues to see risks remaining to the downside.

Mr Draghi’s remarks on inflation were interesting. As was the case a month ago, today’s opening statement omitted the traditional reference to inflation risks as being balanced, thereby hinting at a measure of concern that low inflation could become a long lasting problem. While Mr Draghi referred to the role of specific factors such as the exchange rate and fluctuations in food and energy prices on inflation trends, he also acknowledged broader cyclical disinflationary pressures-a development emphasised by the unexpected drop in ‘core’ inflation data for September released earlier this week.

Mr Draghi’s acknowledgement today of the ECB’s concerns in relation to activity and inflation weren’t dramatic nor was his outline of the ECB’s response ground-breaking. That said, we think there were clear indications of ongoing concern and subtle but important pointers as to how the ECB sees monetary conditions easing further in response. 

ECB Preference For A Softer Currency Fairly Obvious

In keeping with tradition, Mr Draghi was very careful in the language he used in response to a number of questions on the exchange rate. However, the ECB’S preference for a weaker currency was probably stated as clearly as could be expected from a major central bank.

There are obvious implications for FX traders in the statement that ‘...our asset purchases should ease the monetary stance more broadly.They should also strengthen our forward guidance on the key ECB interest rates and reinforce the fact that there are significant and increasing differences in the monetary cycle between major advanced economies’.

Lest there be any doubt of Mr Draghi’s intentions in this regard, he repeated today that the exchange rate was not a policy target but emphasised on a couple of occasions its importance in terms of price stability and growth. With growth and inflation both falling short of expectations, the implications for the exchange rate of the Euro are fairly clear. To drive home the point further, Mr Draghi alluded to G20 terms of reference that shun competitive devaluations but accept the implications for currency movements of policies focussed on domestic price stability.

Mr Draghi Attempts To Switch Emphasis From A Specific Increase In Balance Sheet

Alongside the implicit encouragement of a weaker Euro exchange rate, Mr Draghi also subtly changed his emphasis in relation to the expectations for the outcome of the various liquidity boosting operations now being implemented by the ECB. Previously, Mr Draghi had indicated that these initiatives could boost the ECB’s balance sheet by up to €1 trillion.

He suggested today that the maximum size of the asset backed securities (ABS) and covered bonds programme combined was around €1 trillion and would be augmented by the targeted long term refinancing operations (TLTROs). More importantly, however, he sought to switch attention away from delivering a specific size of programme to delivering a desired impact on inflation and inflation expectations.

In part, this change of emphasis likely reflects an acknowledgement of growing market concerns that a possibly disappointing take-up of these programmes coupled with the maturity of a number of other liquidity boosting measures would mean any expansion of the ECB’s balance sheet is likely to be considerably less than €1 trillion. Mr Draghi’s changed tone also reflects the very uncertain impact.

Mr Draghi’s changed tone also reflects the very uncertain impact of asset purchase schemes on economic conditions. A newspaper report earlier this year claimed internal ECB studies had suggested €1 trillion of asset purchase would have an impact on inflation of between 0.2 and 0.8 percentage points implying considerable uncertainty about the extent to which the ECB balance sheet would need to expand in current circumstances. Mr Draghi indicated today that the ECB could deliver the size of balance sheet necessary to push inflation towards its target.

It would be very unfortunate if Mr Draghi’s earlier comments were to cause markets (and policymakers) to focus attention solely on the size of the ECB’s balance sheet. So today’s comments are welcome. Quite apart from the technical problems the ECB might face in delivering a particular balance sheet target, lessons from Japan suggest the quality of credit easing is at very least as important as the quantity of assets purchased.

Unfortunately, while rightly playing down the crude numerical balance sheet size as a measure of the success or otherwise of this scheme, Mr Draghi did not suggest any simple alternative.  To the extent that markets think the balance sheet may not increase as much, some of the recent downward pressure on the Euro could be reduced. Indeed, concerns in this regard could explain some of Mr Draghi’s comments today in relation to the currency.

Equally significantly, Mr Draghi said today that the impact of these actions would be assessed ‘in coming months’ implying the timeframe before other measures might be contemplated may be somewhat shorter than generally envisaged. In turn, this may hint at either pronounced optimism or pessimism about the likely consequences of these asset purchases. So, the ECB remains very much in activist mode even if it wants to avoid being pressured to announce something new every other month.

No Major Surprises In Details Of Asset Purchase Scheme

Our sense is that a number of interesting aspects emerged from Mr Draghi’s comments today even if his desire not to overcommit appears to have disappointed markets. On the face of it, markets should have been braced for a complete lack of fireworks. Today’s ECB meeting was not anticipated to do anything more than set out details of the ABS and covered bonds purchases programmes which were announced a month ago. These details contained no major ECB Hints Not Enough To Reassure Markets2 October 2014 5 surprises. The ECB indicated that these programmes will last at least two years with covered bond purchases beginning as early as the second half of this month.

There has been significant debate in relation to the quality of assets that might end up on the ECB’s books. Greek and Cypriot assets that might fall below ratings criteria will be eligible ‘subject to specific rules with risk-mitigating measures’. In addition to various additional technical requirements set out in documentation released separately today, Mr Draghi added that the two countries would have to be participating in formal assistance programmes. At the margin, this may cause some problems for Greece as it is scheduled to exit its bailout programme in early 2016.  Presumably, this stipulation represents a somewhat awkward and possibly ineffective compromise designed to appease concerns that the ECB could end up as a ‘bad bank’ because of the quality of some of the assets it might purchase though these schemes.